One of the components of successful binary trading is to have a good trading system. This trading system is not just about having a binary options strategy. It encompasses a strategy which is able to analyze assets for potential profit opportunities, an entry and exit strategy as well as a money management strategy. So it is not just about being able to predict asset direction or asset behaviour. All binary options expire, so your predictions must come through within the allocated time for the trade.
In understanding how to prepare a sound trading system, there are some trading basics a trader should be familiar with.
- Binary options payout roughly 80% for successful trades, but losses incurred amount to a loss of 100% of invested capital. In essence, two winning trades are needed to overcome the effects of a losing trade, provided the trade amounts used in the trades are the same. If the investment amounts for each trade are different, this will alter the risk-reward dynamics and will need a complete revamping of the binary options strategy for the trader to remain profitable.
- There are various trade types and they all require different approaches in order to attain successful trades.
- How to trade is not just about knowing how to place orders. You must know the behavior of the assets you want to trade. For instance, some assets are capable of very large movements at certain times of the day, while some assets only make small movements at a time.
- You must understand the challenges of each trade type before you decide to predict the outcome of the popular binary options assets.
- You must know the optimal trading times for the assets you are interested in trading. For instance, some commodities are not traded at certain times of the day. The stock markets are only open at certain hours of the day, and the trading hours of the Dow and the Xetra DAX are different. Time zone differences matter. You have to take all these into cognizance in planning your binary options trading system.
Components of a Binary Options Trading System
What are the components of a binary options trading system?
- Drafting a profitable strategy.
- Understanding the reward-risk ratios.
- Deploying a good money management system.
All these factors must align together to produce the desired outcomes in the market. Here is a brief description of how these factors can be made to come together to produce the desired outcomes.
- Drafting a Profitable Strategy
The binary options strategy refers to the system of analysis that leads the trader to decide on the prediction to make. The trade type will determine what goes into the strategy.
- For the Call/Put trades, this is purely based on asset direction. The desired outcome is for the asset to be higher or lower than the entry price when the trade expires. The trader only needs to predict correctly, and if the asset ends up in the chosen direction by even one pip, the trade is adjudged a winner. Most trades of this nature have expiry times that start at 15 minutes and can extend to 1 or 2 hours.
- For One Touch trades, the prediction outcome is dependent not just on asset direction, but also on range of asset movement. This is because there is a price target that must be achieved. This price target is placed by default at a set distance from the market price. Therefore, the strategy must look at asset direction and also determine if the volatility of the asset will take it to the strike price for the trade. This must all happen before the trade expires.
- Short term trades such as the 30 seconds and 60 seconds trades are dependent not just on market direction but also on whether the asset has the required volatility to end up above or below the market price in a very short term. Slippage can alter the trade outcome in a negative way. Can the strategy surmount this challenge?
Each trade type comes with unique challenges, therefore it is impossible for one binary options strategy to be devised for all trade types. The best choice for the trader would be to go with a prediction type for which a binary options strategy can be devised.
- The Reward-Risk Ratios
In forex, it is possible to get trades with reward to risk ratios of 3:1, which makes it possible to get profits from one good trade that would require losses from three trades to erode. This is not the case in binary options. If the same investment amount is used in all trades, the binary options trader needs two winning trades to counter a trade loss, and still have some amount left as profit. In short term trades, the winning payouts are even less, requiring three successful trades for every trade loss to balance the portfolio. The strategy to be used must be capable of delivering these targets without fail.
- Money management
Money management is intricately tied to reward-risk ratios. First, money management techniques must be able to protect the account from a string of losses. The market standard is for open positions to take up just 3-5% of account capital. Anything higher would seriously jeopardize the safety of the trading account. Secondly, risky strategies that attempt to double up on investment amounts after losses have been sustained should only be attempted by those who know what they are doing. So a good strategy must incorporate sound money management techniques as these are what protect trading accounts from the effects of losing trades.
Testing Your Binary Options Trading System
Before you use any binary options strategy on a real money account, you need to test and optimize such a strategy. This must first be done on the platform of a broker that provides a demo account without deposit. The reason why this is done is because the popular brokerage platforms are all web-based and cannot be downloaded to a desktop computer.
In testing and optimizing your trading system, you should look at the following:
- What trade types will suit your strategy? The conditions which affect the outcomes for the different trade types have already been discussed earlier in this article.
- What time frames will suit your strategy? Will the trading system be better suited for long term options, or will it withstand the potential torrents that come from trading the short term options such as the 60 seconds option?
- Is it possible for the strategy to be automated? In other words, can a robot be made out of the strategy to provide round-the-clock trading?
- Can strategy be duplicated across all asset classes, knowing fully well that the fundamentals that affect stock price movements are not necessarily the same that affect currency price movements?
- What is the reward-risk ratio for the strategy in a week, month or a year? Your strategy must be able to deliver at least 3 profitable trades for every trade loss. Due to the extreme importance of this point, we will illustrate it below.
Trader Joe invests $100 into every Call/Put trade he makes. Winning payout is 80% per trade, losing trade leads to 100% loss of $100 investment in a trade.
- 3 successful trades -> (80% of $100) X 3 = $240.
- 1 losing trade = -$100.
- Profit after 4 trades = $240 – $100 = $140.
Assuming he performs a total of 12 trades a week or 48 trades a month, a 75% success rate (36 winning trades) as shown above will lead to profits of $140 X 12 = $1,680, which is not bad for such small trade sizes.
Assuming another Trader Brando trades 60 times a month with the same investment size of $100 and gets 36 successful trades, what does it translate to?
- 36 successful trades = (80% of 100) X 36 = $2,880
- 24 losing trades = – $100 X 24 = -$2,400
- Profit = 2,880 – 2,400 = $480
You can see the difference in performance between Joe and Brando, even though Brando traded more times and had the same number of winning trades as Joe. This example clearly shows why a binary options strategy needs to deliver a good return on investment for a sequence of trades.
Q: What is a binary options strategy?
Answer: A binary strategy is a technique which can be implemented in to charts in order to identify patterns or trends in an assets price. Some of the beginners strategies include the Pinocchio, trend line identification and trading the news.
Q: What is a trading system?
Answer: A trading system is an overall plan which includes the trading strategies you have decided to use and a risk management plan eg. how much capital will you invest on each trade and what will you invest the next time should your trade fail or win. Many traders use an excel datasheet in order to keep a clear picture of their trading system. This helps fight against the human instincts to act out of fear and greed.