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How to build a binary options strategy

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Binary options trading
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Lesson 11

There are no doubt many ways to put a bell on a cat, and there is no telling which is the right way of doing it. Similarly, with binary options trading, there are many different ways to build a trading strategy, and there is no right way to go about it.

Imagine a hundred traders are using the exact same strategy. You will probably see a hundred different outcomes with that one strategy. It is not the strategy rules, but your skills and how you read the market.

Just like any new pattern, a trading strategy requires time to understand and get used to. You cannot expect to make a profit right off the bat just because the strategy made money for some other trader. The truth is traders need to spend time analysing their trading strategy before they can expect to make a profit from it.

Building a trading strategy can be done in many different ways. However, no matter what approach you take, the bottom line is you must have some knowledge of how the markets work and, more importantly, about the technical indicators that might be used when building a strategy.

So, the question is how does one build a trading strategy and what are the methods one can use?

Support and Resistance levels

Support and resistance levels, or supply and demand, are concepts that form the lifeblood of any technical analysis. No matter how you analyse the markets, you will find support and resistance are in play. Take for example moving averages. Price often makes a pullback, and in many cases, you will find this pullback coincides with a support or a resistance level.

As a trader, it is important to understand how support and resistance levels work. However, make no mistake in thinking that price will always reverse at a support or a resistance level. Rather, try to understand how support and resistance levels work and, more importantly, what to expect. Following how price behaves around these levels can help a trader make more informed trading decisions.

There are many different support-and-resistance-based trading strategies. The simplest are round numbers, which are easy to spot. Support and resistance levels work best when combined with technical indicators or candlestick patterns.

Chart patterns

Chart patterns are another great way to trade naked. Trading naked doesn’t mean having to take off your clothes while trading, rather it is a term applied to trading without the help of any technical indicators, such as Moving averages or Bollinger bands.

There are many different chart patterns, and for traders, it can be easy to get lost in hunting for these patterns. Another important aspect when building a trading strategy with chart patterns is that you need to bring an element of subjectivity.

This can be tricky, at least initially, because it takes a bit of time to get used to the chart patterns. Some of the easiest and widely recurring chart patterns are the head and shoulders pattern, the wedge pattern, the flag pattern and, of course, the triangle pattern.

An element of uncertainty involving chart patterns trading is not being able to tell whether price will move as expected. For example, in most of the chart patterns outlined above, price is expected to move a certain, projected, distance.

However, there is no rule that price has to move as expected. Just as chart patterns occur, so can they equally become invalidated, and that is part of the game. Traders need to realize this aspect when trading with chart patterns.

For a trader building a trading strategy with chart patterns, it is essential to spend a lot of time analysing the patterns that form. One of the key elements to successfully trading with patterns is that experience and chart time matter.

A simple way to improve one’s technique, when trading with chart patterns, is to combine candlestick patterns, which can help in gauging the sentiment.

Despite the apparent cautionary notes about the risks involved with building a trading strategy using patterns, binary traders are at a distinctive advantage over forex traders. In binary trading, because the direction matters relative to the time frame, one can find better success in using a chart-pattern-based trading strategy.

Trading indicators

Trading indicators are, of course, the first place traders go to when they want to build a binary strategy. This is because there are so many indicators available these days, each trying to outdo the other.

A good example is the different types of moving averages available. In addition to the regular types of moving averages, such as the simple, exponential, linear weighted and smoothed moving averages, we also have the hull moving average and Arnaud Legoux moving average to name a couple.

Still, nothing can come close to the simplicity of a simple or an exponential moving average. In addition to moving averages, another commonly used indicator is the Bollinger bands indicator, which is a great technical indicator for measuring both volatility and trend.

Last is the Stochastics oscillator, which helps in timing the entry of a trade. What’s unique about these, rather standard technical indicators, is that a trader can build different types of trading strategies using just these indicators, but only if that trader truly understands how these indicators worked.

Here are some quick tips to help understand how these basic technical indicators work.

A moving average or a pair of Moving averages are ideal to measure the trend and, of course, the rising and falling momentum measured by the distance between the short-term and the long-term moving averages.

The Bollinger bands indicator is ideal to measure volatility. Expanding bands signal rising volatility, while contracting bands signal falling volatility. Using the Bollinger bands, binary traders can build a strategy that can help them avoid these low volatility markets. Typically, a binary trader wants to trade when volatility is high, so his or her trades have a higher probability of closing in the money.

Then, there is the Stochastics oscillator, which can be used in a number of ways, from detecting price divergence to identifying overbought and oversold levels to showing the pull backs in a trend. The Stochastics oscillator is ideal when used alongside the moving average indicators.

Fundamentals

When it comes to building a trading strategy, it is not just the technical aspects that play a role but also the fundamentals, which are mainly responsible for moving price around. Building a trading strategy with fundamentals might seem difficult to fathom, but it is relatively simple. Of course, binary options trading with a fundamentals-based trading strategy is ideally used on very short-term expiring contracts.

There are many examples of using fundamentals as a trading strategy. The most common is trading 60 or 180 second expiring contracts around the United States nonfarm payrolls (NFP) report release. As a high impact economic news release, the NFP can often result in sharp price swings that fit perfectly within the short-term binary options contracts.

In addition to the NFP, traders can look at other events that have a binary outcome. Examples include GDP reports, inflation reports and, of course, unemployment reports. When trading binary options with fundamentals, the strategy needs to be sound and should fit the time frame in which one is trading.

Surely, it doesn’t make sense to trade inflation expectations or an economic forecast report that speaks about a yearly forecast when you are trading a 60 second expiring contract.

A binary trading strategy should ideally encompass both the technical and fundamental aspects of trading, so it gives the trader a full picture of what the markets are doing.

Remember that trading is all about picking trades that you or your trading system thinks have the highest probability of achieving the objective.

Success with building a trading strategy comes only after that strategy is put through a rigorous test and, more importantly, when a trader can truly understand what message his or her trading system is conveying.

Comments

Prime's picture

Great lesson, big thanks for the provided information)

Prime
Joseph-Mc's picture

Thanks Toni, it is a very useful article.

Joseph-Mc