A binary options strategy or trading system consists of 2 core components.
- A method for selecting options; that is to call or put on what asset.
- A method for deciding how much to invest per trade.
Take your time and start out small to try a few different binary option strategies and always be looking to modify and improve your system as you gain experience and data.
These are the 3 main ways of selecting what option to take and when.
- Fundamental analysis.
- Technical analysis.
- Trading on news.
Let’s look at each individually.
Fundamental analysis is investigating and understanding the real underlying value of an asset to form an opinion of whether it is overvalued, correctly valued or undervalued. In the case of stocks this means analysing the company’s product, management, balance sheet, growth potential, strategies, demand et cetera as well as the current price.
In binary options trading if you believe the asset is overvalued you can place a put option predicting the value of the asset will go down. If you think the asset is undervalued you can place a call option predicting the value will rise.
Technical analysis chooses investments based on market trends and market tendencies. People who use this method for selecting binary options assume that all the factors which the fundamental analyst considers, are already priced into the market. However the value of the asset may rise or fall based on sentiment and market mechanisms.
These market mechanisms include market data such as past prices, volume traded and any cycles and trends that may be active.
For example if a currency is trading within a range from 1.041 to 1.049, a trader applying technical analysis will make a call option for the currency to rise when it is at the bottom of the range and place a put option for the currency to fall when it is at the top of the range.
Trading on news
This is a simple and easy technique that requires no special knowledge or skills to profit on. Simply find out what important financial news is going to be released. This could be unemployment figures, interest rates or a company’s annual report. Find out what key number the market expects, what range would be better than expected and what range would be worse than expected.
If the number that comes out is better than expectations the related asset will rise so make a call binary option. If the number is worse than expected the related assets will fall so make a put binary option. Related assets are things like Apple stocks for Apple corporate results or the US Dollar for US employment rates.
The week before I wrote this, US unemployment figures were released and they were much worse than expected. This almost guaranteed that the EUR/USD would rise sharply, and it did. We were able to make large investments on that at one broker with the standard 180% payout! Happy days.
Another way to trade news is to find out what stocks or assets the media is buzzing about or putting down and follow the short term sentiment.
Which method to use
The best traders combine fundamental analysis with technical analysis and are aware of the news. That is to say if an asset is undervalued based on its fundamentals and the market conditions make it likely to rise, that is the asset to invest in by making a call option.
Keep in mind that binary options are very short term investments of 1 month maximum. This makes them less suited to fundamental analysis as even if an asset is undervalued when you open your option it may still be undervalued when your option expires. Technical analysis and trading on news can work very well for typical 10 minute options.
A signal is something you believe can help to predict the direction of a market. If whenever XYZ happens the market goes up then XYZ is a signal you can watch for, then when it happens make a call trade!
All the above methods use signals found in data, so signals are almost always numerical. The exception being trading on news or sentiment, for example if Warren Buffett says he loves a sock that could be a signal but it is not a numerical signal.
Even well researched and timely trades that have a positive expectation sometimes lose. That is why we get 80% payout if we win. For that reason you should exercise bankroll management and only invest a small % of your bankroll in any 1 binary option.
If you invest 10% of your bankroll you can only go on a losing streak 10 trades long before you go bust so that would normally be considered too high. 2%-5% is reasonable but it depends on your own risk tolerance and confidence.
If you enjoy the risk and are very confident in your selections then 5% or more could be appropriate. If you are not sure about your selections and have a low tolerance for risk then 2% or less could work for you.
What you don’t want to do is increase your stake after losing options to chase your losses unless you have a stop loss or are willing to lose your bankroll. This would be gambling not investing.
You can read more about bankroll management and everything else you will need to have in place to support your trading strategy at how to be a winning binary options trader.