What are Binary Options?
To describe what a Binary Option is, we need to start by defining what an option is to begin with. An option is as simple as it sounds; it gives you the option to buy or sell an asset at a price agreed upon in advance. A Binary Option then is a financial option with which you either get a fixed amount of money or another asset, or nothing at all. The payoff is decided on whether the option at the date of expiry ends in-the-money (e.g. over the set price) or not.
You can either buy or sell an option, depending on your view on the underlying asset. Say you buy an option at 10£, and at the date of expiration it trades at 20£. This means that you make a profit of 20£ – 10£ = 10£, and you are in-the-money. Had you sold the option however, you would gain nothing and made a loss of the whole sum you paid for the option.
When you believe a certain asset will increase in price in the short term, you buy an option (a call option). When you believe the asset price will fall in the short term, you buy a put option (which is the equivalent of shorting or selling an asset).
What do you need to start trading Binary Options?
The reason you need a Binary Option trading strategy to begin with is to remove the emotional and irrational aspect of trading. Of course, you can still choose to trade without using a strategy and only based on your instincts, but then your trading style will be fairly random and not susceptible to improvements over time.
Binary Options can be traded via brokerage firms online. At this stage, it is quite important to do your due diligence and check if the brokerage you choose is serious or not. Stick to large brokerage firms with good reputations. The risk otherwise is that you fall in the hands of a brokerage that can rig the price, as the brokerage acts as price setter, as Binary Option trading is not a regulated business.
Once you have found a brokerage you are happy with, it is time to choose an asset, e.g. gold, stocks.
Successful Binary Options Trading
As with all type of trading, you need to know yourself and set limits in accordance to
- Your risk profile and
- The money you have available to trade with, which should not be over a set percentage of your total trading portfolio
- Understanding that Binary Options focus on the short-term movements
- Never investing too much in one and the same trade, e.g. preferably 5-10% of the money you have set aside for Binary Option trading
With that said, let us look at Binary Options strategies and which ones you should choose depending on your trading style and trading profile. A good trading strategy will generate a buy or sell signal for you, thus letting you know when to trade and when to exit a trade. It will also let you know how much money you should invest in one single trade.
The first step is for you is to decide on if you are a trader who rather:
- Trade on information, e.g. news and market changing events
- Trade with a systematic approach and/or technical, e.g. using technical analysis and/or algorithms.
These are strategies that are relevant for most assets that are available for trading. The style preferred and used depends on what comes most naturally to you, e.g. if you rather trade based on information or on a mathematical approach. Of course, there is nothing stopping you from using a mix of the two.
If you are a information and/or news oriented trader, you need to set a list of tools to help you keep track of the news and information that may affect the price of your option. There are many websites and brokers that can provide you with the information you specify, via RSS-feeds, e-mail or other notifications of your choice. Economic calendars, following certain Twitter accounts or websites; choose your information sources and stick to your plan regarding the signals they generate.
The same goes for technical analysis and algorithms, where the latter is more suited for traders with programming knowledge. We need to stress at this point that you should not use algorithms you do not understand or that you have not back-tested yourself. Technical analysis is an easier alternative to algorithm, which does not require programming competencies. Technical analysis is based on finding patterns in the fluctuations of certain parameters such as price, volume and other aspects that may affect the value of your trading position in a Binary Option.
Whichever strategy type you wish to proceed with, testing it using paper trading (i.e. following a position as if you had invested money in it) is recommended prior to using the strategy in real life. Also, once you do start implementing your strategy, it would be best to test it for ca 30 trades and continue with it if it is profitable.
Well underway with your strategy, do not forget to evaluate it and if needed, update it and iterate the paper trading, test and implementation process.
When setting a Binary Option strategy, it is important to map:
- Your risk profile and being comfortable trading short-term
- The means you have with which to trade
- Whether you prefer to trade using technical type of trading or information based
- A reliable brokerage firm
Once you are ready to start trading Binary Options, you need to:
- Choose an asset with which you based your trade on
- Paper trade the strategy you have chosen
- Implementing the strategy and
- Evaluating the strategy continuously or at certain points in time
A successful strategy is one which:
- Generates buying and exit signals
- Tells you how much to trade for per trade position
- Is in line with your way of trading (e.g. technical or information/news based)
- One that of course has a positive net result after trading costs