If you are new to the world of binary options trading, then we would like to take this opportunity to welcome you to this exciting world of online trading. As a novice trader, the good news is that you can trade binary options without any prior experience as well as without any understanding of how and why the markets move. Despite this, as with anything in life, the more you know about something, the more successful you will be at it and this applies to options trading as well.
Options Trading For Dummies
In our quest to convert you into a pro trader, let us start with the basics. Binary options trading involves trading in options (obviously) and these options only have two possible outcomes. That is, you will either win a fixed amount of money or you will lose a fixed amount of money, there is nothing in between. This can be viewed as one of the advantages of options trading since you know even before you make an investment, what you stand to win or lose. This form of trading requires the trader to make a prediction of the direction that the price of an asset will move within a specified time namely, up or down. For example, you need to predict if the price of Coca Cola shares will move up or down after 15 minutes. You do not need to predict the magnitude of the price movement, only the direction. So in explaining this stock option in dummies terms, you will not need to predict if the price of Coca Cola will reach $50, you only need to predict if it will move up or down. If you predict correctly, we say that your trade has ended in-the-money and you will win the fixed payout ratio which can be up to 85% of your investment amount. If on the other hand, you predicted incorrectly, your trade is said to be out-of-the-money and you will lose a fixed amount of money. In some cases, this can be the full investment amount or if the broker offers a rebate on losing trades, you can get back up to 15% of your initial investment amount.
So you might be wondering where you can trade these options online. A binary options broker will give you access to their trading platform and from here you can select the asset you want to trade in as well as the expiry time of the trade. You can then enter the amount you want to invest and if you think that the price of the asset you have selected will increase, you can click on the ‘Up/Call’ button and if you think that the price of the asset will decrease at the end of the expiry time selected, you can click on the ‘Down/Put’ button. It really is these simple and even dummies can master this online form of day trading.
An important fact to point out at this stage, is that options trading does not involve the actual buying and selling of assets. Instead, you are only making a prediction about the direction that the price of the asset will move and for this reason, we refer to these assets as underlying assets in options trading. The assets you can trade in can be a stock, a currency pair, indices and commodities. In dummies terms, stock trading involves trading a stock such as, Google, BP, Coca Cola and many more, whereas commodity trading involves trading gold, silver, coffee and more.
This covers the basics of trading binary options online trading and while it sounds like you can guess the direction that the price of the asset will move, having an understanding of the markets as well as what factors influence these movements, will help you to trade more accurately. In order to do this, let us look at fundamental and technical market analysis.
Fundamental Market Analysis
The market is influenced by many factors, some which can be predicted and others which cannot. In order to understand how the market will move, traders use Fundamental Market Analysis. This involves interpreting the market data of an asset as well as the economic climate and how this will impact the financial movement of an asset. Fundamental analysis takes account of various factors such as market and financial news, company news, predictions and announcements. For example, when Steve Jobs died, it created a crisis in the company and the value of Apple shares fell. Investors were wary about the changes in leadership and investors did not know how Apple would perform under its new leader. This kind of news originating from within a company can actually affect the company’s overall market value. As it happened in the case of Apple, those who preferred trading in Apple stocks went for Put option trades as they predicted that the price of these shares would drop. In this case, these predictions were accurate and these traders made a profit. In order to master fundamental market analysis, you should read the financial news on a daily basis so that you can get an idea of what is happening in the markets and how these events will impact the asset prices.
Technical Market Analysis
This form of market analysis focuses on the price of the assets taking into account the historical price movements. Using trading charts, indicators and statistical tools, we are able to predict the future movements of an asset. Technical analysis is built on the assumption that history will repeat itself and that prices follow specific patterns or trends which is dependent on the demand-supply equilibrium. Technical market analysis is all about prices of the assets. External forces and major events can affect the demand and supply of an asset thereby causing it to change its price movement. Despite this impact, prices of assets are generally expected to move back into their patterns making it easier for us to predict future price movements.
With both fundamental and technical market analysis, you will be able to fine-tune your predictions which often leads to positive results and more profits. But let us look at other important elements of the markets.
Bull versus Bear Markets
A market is called a Bull Market or is said to be Bullish when there are long-term upward trends. This means that the confidence of the investors is increasing and they are increasing their investments with the anticipation that there will be future capital gains, that is, the prices will rise in the future. This generally happens when the economy of a country shows a solid growth rate over a long term.
On the other side, a market is called a Bear Market or is said to be Bearish when there are long-term downward trends. This means that the investors are losing their confidence and the high optimism is transitioning into deep pessimism.
A market is tagged Bullish or Bearish after there is at least a 20% rise or fall over a period of 2 months.
Using these terms, if an asset price is bullish in nature, it means that it is showing an upward trend and in this case you would make a Call option trade on the broker’s trading interface and the opposite would apply to an asset price that is bearish in nature. Here you would make a Put option trade.
Let us move on now to market trends.
Market trends use the price data of assets in order to predict the direction in which the market will move in the future. An upward trend will reflect a bullish sentiment while a downward trend will reflect a bearish sentiment.
To begin trend analysis, you will need a price chart of an underlying asset. Here you will notice that prices always move in the form of waves which have crests and troughs. That is, sometimes the waves move in an upward direction and sometimes they move in a downward direction.
In order to trade properly, you will have to plot a trend line. In order to do this, you will have to identify the direction of the trend on the price chart. So for example, here in the diagram below, we have an upward trend and the price wave shows higher troughs at different times. Now you can draw a straight line that will join all the bottom-most points of each trough.
With this upward trend you can now easily speculate that following the normal wave cycle, when the price comes down to hit the trend line, it will bounce back upwards indicating that in the future, the asset price will increase. This is when you will make a Call option trade as there is an upward trend in the price of the asset.
Similarly, for a downward trend as in this diagram below, the crests at different times are getting lower. If you draw a straight line touching the topmost point of each crest, this will give you a downward trend line. When the price of the asset moves up to hit the trend line, it may bounce back downwards indicating that the in the future, the asset price will decrease. When it does, this is when you will make a Put option trade as there is a downward trend in the price of the asset.
You can take advantage of market trends by observing the current direction of an asset price and then you can use this information when you trade.
We have reviewed the different elements of the market and now we will move on to a basic trading strategy which is known as Hedging.
The Hedging Binary Options Trading Strategy
A binary options strategy is a method or a plan for placing trades in the binary options market with an objective of winning the trade or minimizing the risk.
Based on this, when you plan a strategy while trading, it is very important to have strong knowledge of the market. This can be achieved with both fundamental and technical analysis as well as trading experience. Different strategies will work under different conditions and learning when to apply them effectively, is key to the strategy’s success.
Hedging or a hedging strategy is a financial position that aims at securing gains and preventing loss while trading. The basis of this strategy is to minimize risks. Hedging is most effective when used under volatile market conditions and it is often used in Forex trading although it can be applied to any asset class.
In binary options trading, the basic concept of Hedging is to place two opposite trades so that if one loses, the other winning trade will reduce the loss amount. So in other words, the basis is to purchase a Call and a Put option trade at the same time so that the Call option is hedged by the Put option and the Put option is hedged by the Call option.
When you do the calculations though, this would be ineffective and you will make a loss. Imagine you invest $100 on a Call option trade and $100 on a Put option trade. If the broker is offering a 70% return on a winning trade and a 10% rebate on a losing trade, you will make $70 on the winning trade but you will lose $90 on the losing trade. You will therefore be left with a loss of $20. The advantage of this though is that your loss has been reduced from $100 to $20.
But there is more to the hedging strategy.
Let us assume that our market analysis points us towards a bullish market. This means that we will make a Call option trade and we decide to invest $100. We will then make a Put option trade but we will invest less money in this trade, for example $50. In this case, if our analysis is correct, and the broker is paying out 70% for in-the-money trades and 10% for out-of-the-money trades, we will make $70 on our Call option trade and will lose $45 on our PUT option trade giving us a profit of $25. While the hedging strategy may reduce your profits, it also reduces your losses making it an effective choice when trading in volatile market conditions.
If you decide to trade the same investment amount on both your Call and Put options, you can use the Double Up feature on the trading interface to boost your profits. The Double Up feature is offered by many brokers and it allows you to create a duplicate trade of an existing trade with a click of a button. So, as soon as you see that one of your trades will probably end in the money, double up the trade so that you can make double the profit on the winning trade. Use the Double Up feature with caution though because the last thing you want to do is create an opposite hedging trade and then double up on the wrong trade option. This will result in some heavy losses so make sure to analyze the market thoroughly before using the hedging strategy and the Double Up feature.
Remember, take the time to analyze the markets and apply your strategy when the conditions and timing are optimal.
Congratulations on graduating from binary options for dummies and stepping into more advanced trading. If you want to learn more about trading tactics and other trading strategies, then download Trading Binary Options Strategies and Tactics PDF now. Anyone can trade binary options but if you take the time to analyze the markets, you can improve your predictions of the direction that asset prices will move, resulting in trading effectiveness, success and profits.