Enhanced Binary Options Trading Guide

What are Binary Options?

We have already published several articles on binary options trading such as “The Binary Lie” and “Advanced Trading Strategies.” In this article we simplify the binary options market, its functionality, how to trade binary options and what steps new traders should consider taking to avoid a financial suicide in the binary options market. Subscribe to DDMarkets to be notified when the next market research is released.

Binary options are a simplified form of standard options. The trader predicts a direction where the financial asset will trend, higher or lower within a predetermined period of time. The financial asset or the instrument could be a currency pair such as Euro-Dollar (EURUSD), a commodity such as crude oil, a stock such as Microsoft or a stock index such as the SP500.

The predetermined period of time means by when the price of the financial asset will trade higher or lower. This time frame could be 60 seconds, 5 minutes, 1 hour, several days or several weeks. The trader chooses the time frame he or she believes the financial asset will trader higher or lower.

This time frame is known as the expiration of the binary option. The trader determines how much to invest in the binary option before executing it in the trading platform of the binary broker.  The invested capital can be anywhere between $25 to thousands of dollars. The profit of a successful trade (prediction) is called the fore and is reflected in the form of percentage points.

Before executing the trade in the trading platform the payout will be displayed. Payouts in the binary options market often range between 70% to 85%. Should the trader decides to invest $1,000 in a binary option and the payout was 85%, if by the expiration the trader predicted successfully the price of the financial asset (higher or lower) a profit of $850 (85% of $1,000) will be added to the account balance.

If the prediction was unsuccessful there would be no profits and the invested capital ($1,000) will be lost.  This is a basic explanation to what are binary options and how profits are earned in this market. Of course, this is just beginning.

The Financial Assets

The Foreign Exchange Market (Forex) is the biggest financial market in the world. In the Forex market, one would find all the currency pairs and crosses such as EURUSD, GBPAUD, AUDUSD, USDCHF etc. The current price of EURUSD is 1.2470. That means one Euro is worth 1.2470 US Dollars. The exchange rate is fluctuating 24 hours a day from Sunday night (GMT) to Friday night (GMT).

Fluctuating means the exchange rate will constantly change, trading higher and lower. If the economic data in the Euro zone improves traders would look to buy the Euro. When the Euro is heavily bought it will strengthen against other currencies such as the US Dollar.

This would take the exchange rate from 1.2470 to 1.2490. Likewise, if the economic data from the Euro zone disappoints, traders would look to sell the Euro, which could drive EURUSD lower from 1.2470 to 1.2410.

It is essential to pay close attention to the fourth digital point, known as a pip. The numerical value of a pip is 0.0001. If EURUSD gained from 1.2470 or 1.2479 it said to have gained 9 pips. If EURUSD drops from 1.2470 to 1.2409 it has dropped by 61 pips.

At the expiration of a binary option trade, if the price is higher or lower (which was your earlier prediction before executing the trade) by a fraction of pip, the payout will be earned or a loss will be made. A fraction of pip is 0.00001, the fifth digital point.

It is a very small movement that takes place even during weak trading hours, which we will elaborate later on. In the trading platform, rather than seeing 1.2470 you will see 1.24708, a fifth digit.

Same for commodities, stocks and indices. Taking crude oil as an example, if the price is $80.50 a barrel, in binary options the high/low price at the expiration will be determined by a fraction of a cent, $80.505. The third digital point is a fraction of a cent. Same applies for stocks. Indices such as the SP500 are traded in points so the rather than a fraction of a cent or a pip, it would be down to a fraction of a point.

These movements are what binary options traders attempt to predict in order to earn the payout.

How do Binary Options Brokers Profit?

In other markets such as spot Forex trading, the broker may earn its profit by being either of those three, a Market Maker (MM), Straight -Through Processing (STP) or Electronic Communications Networks (ECN).

Market Makers

MM brokers do not process their clients’ trades into the market. They receive the market quotes (the rates) from a third party and transmit it to the trading platform. As the trades are not released to the market, the clients’ losses will find their way into the broker’s bank account and any profits would have to come out the broker’s pockets.

MM brokers rely on the debatable statistics that most traders will lose in the market, the reason is irrelevant at the moment. In order to succeed, the broker must heavily promote itself to draw many traders into its platform.

When there is a great amount of traders in the platform, any profits trades will make will come from traders that have made significant losses, ensuring the broker will not require to open its very own pockets. The more traders there are trading with the broker, the higher its profits would be due to the debatable statistics that the majority lose their money in the market.

Of course, the broker exercises risk management procedures, which we will not discuss in this article in case a trader decides to place a significant amount of capital in a single trade, which if he or she profits could dent the broker’s profits.

The greatest fear of trading with MM is the fact the broker controls the market price, which does leave room for price manipulations in order to force its traders to post losses. There are regulatory bodies that supervise the broker’s activity but nevertheless the fear does not evaporate.

One of the signs of MM are re-quotes. This happens when a trader wishes to execute a trade and a message pops up saying the trade has been refused while offering a different price, often a worst price for the trade that was attempted to be executed.

STP Brokers

STP brokers do not execute their clients’ trades in the market directly but pass it on to the liquidity providers to be executed. STP means trades may be processed faster as there is no need for a Dealing Desk (DD) which is often a part of a Market Maker.

As a result, re-quotes in STP brokers are extremely rare. The broker nevertheless has the ability to determine which trades will be executed in the market and which will not.

Large trades (let’s say above 20 million dollars) and traders with a successful record will be forwarded to the liquidity providers while small trades or traders with a weak record will be not be processed in the market. There is a special algorithm that determines one’s records, it is not done manually.

ECN Brokers

ECN brokers offer a direct market access for all traders. As ECN brokers do not profit from their clients’ losses there is often a minimum deposit required ($20,000 for example) and a minimum trade size to ensure the broker is able to profit.

Some ECB brokers charge a fee based on the trading volumes and set a minimum requirement of volume per month. All brokers, MM, STP and ECN charge a mark-up known as the spread. It means the broker adds a certain amount of pips to the trade as a commission.

For example, if a trader buys EURUSD at 1,2470 in the Forex market (not binary options), the trader would begin the trade with -2 pips. If EURUSD trades 2 pips higher, the trade will breakeven and anything above will be the trader’s profit.

Binary Options, Forex and Price Manipulations

In binary options, all brokers (at the time of this writing) are Market Makers. The reason for that is due to the fact there is no market to process the trades to. Binary brokers are also based on the statistics the majority will lose in the market and heavy promotion is required in order to maintain a large amount of traders in the platform.

As there is no spread in binary options brokers favour unsuccessful traders, which is their source of income. If the trader is successful, an established binary broker will have the ability to pay the profits as there are many traders in the system that generate a decent profit to the broker’s pockets.

If the broker is regulated it is unlikely to take any steps that would prevent you from profiting. There is only one regulatory body in the binary options market and this is Cyprus Securities and Exchange Commission (CySec).

Stop Hunting

In the spot forex market, price manipulation is conducted in a way to trigger stop loss orders. A stop loss order is set by the forex trader to limit the losses of a trade went against the predicted direction. For example, if the trader buys EURUSD at 1.2470 (predicting the price will rise), a stop loss order can be set a 1.2420.

If EURUSD drops 50 pips the trade will be automatically closed, ensuring the trader will not incur a greater loss than 50 pips. The price manipulation, which has been labelled as ‘stop hunting,’ is to trigger these orders when the market price is within a close proximity to the stop loss orders.

A small artificial movement, often less than 5 pips is all that is required to ensure the trade will end with a loss. The capital the trader has sadly departed from will make its way to the Market Maker’s pockets.

60 Seconds Expirations

In binary options, such price manipulations cannot occur as there are no stop loss orders. Nevertheless, price manipulations may occur at the expiration. If you recall, a fraction of a pip is all that is required for a binary option to expire with a profit.

Let’s say you place a binary option predicting EURUSD will rise at the end of 15 minutes, current price is 1.24705. If in the last 30 seconds of the trade before the 15 minutes are up EURUSD is trading at 1.24951, the broker will not drive the price lower to 1.24702 as it will be noticed. However, 30 seconds, 60 seconds, 2 minutes and 5 minutes expirations can be manipulated if the market price is near the price the binary option was executed.

For example, if a 30 seconds binary option trade was executed at 1,24705, if in the last 3 seconds of the trade EURUSD is trading at 1.24708, the broker can drive the price lower to 1.24703 for just 3 seconds to ensure a loss will be incurred and also go unnoticed as it is just a fraction of a pip.

This can be done with any expiration but most likely present the broker with more opportunities to manipulate the price with the short-term expirations we have discussed. The only way to prevent from being exposed to such possible manipulations is to consider to use a larger expiration such as 30 minutes and above.

We can tell you that many traders prefer the 30 or 60 seconds trades as it is “fast money” and resembles gambling many ways. We would therefore suggest adopting longer expirations in order not to be butchered by the binary broker.

As we wrote earlier, re-quotes are a sign of a dishonest market maker. Re-quotes can happen but on rare occasions. In binary options, a re-quote is often see when trader wishes to exit the trade before the expiration with some profit or a smaller loss. If you encounter multiple re-quotes on closing a trade before the expiration in several different trades do complain to your broker to resolve the matter.

Binary Options Payouts

Another interesting topic would be the payouts. You will notice that the payouts are not the same for all assets. There is a very good reason for this and it is called “risk management.” As we have discussed earlier a Market Maker must adopt risk management techniques to protect its profits.

In assets that there are less people trading will mean there will not be a “healthy balance” between profits and losses. The broker would therefore reduce the payouts in accordance to the amount of traders trading the asset. EURUSD and GBPUSD for example are in top most traded assets so the payout is likely to be the highest. If we will take EURNZD for example the payout is likely to be lower.

During the night (GMT) at the Asian session there are less binary options traders in the platform. The broker will therefore act and reduce the payouts for most assets until more traders join the platform, which is often in the morning (GMT) at the European session.

If you are new to trading binary options please be aware that the majority of the representatives you will be communicating with are insufficiently, financially educated and lack the required skills to teach how to trade binary options.

It essential you will spend time learning the market. After we have discussed how the binary options market functions it is time to proceed into trading strategies.

Binary Options Trading Strategies

Binary options trading strategies are similar but different to other markets. We will elaborate on several trading strategies but be aware there are many more.

The Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a technical indicator that reflects when the financial asset is overbought and when it is oversold. Above 70.0 is considered overbought while below 30.0 is considered oversold.  If you are relatively new to binary options you may have heard about the RSI from the broker’s representative.

To simplify the strategy, when the RSI is oversold, the price is likely to trade higher as there are too many sellers in the market. Wen the RSI is overbought, the price is likely to trade lower as there are too many buyers in the market. The immediate problem in adopting the RSI into binary options is the fact your limited in time and each fraction of a pip is crucial.

It is very likely for the price to continue to trade lower (let’s say 10 pips) before trading higher. In other markets you are not limited in time, you may hold the trade as long as you wish. In binary options, the expiration confines you to a certain time frame to your disadvantage, hence the great payout.

The RSI

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Adopting the RSI for binary options is only superficial. It will provide the trader with a direction to consider but other tools are required to increase the success rate of the trading strategy. Aside this, relying on one indicator is insufficient.

Support and Resistance Levels

Support and resistance levels will provide you with an indication as to where the price is heading. Support and resistance levels are used in many markets including Forex, Future, Bonds etc. and are not limited to trading binary options.

A support level is a certain area that the price was unable to fall below. To simply, it is an area that the market price has reached but immediately rebounded higher. The resistance level is the opposite. It is a region the price was unable to break above and retraced lower.

Support Level Example

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A support level is determine by at least two tests (when the market reaches the support level and trades higher). The third time the price reaches the support level and does not break below, this would the point where a rebound is expected and may be capitalized on in the binary options market.

Resistance Level Example

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 A resistance level is also determined by two  tests. Similar to the above, the third time the price reaches the resistance level and does not break above may act as an entry in the binary options market, predicting the price will trader lower.

Combining the RSI with support and resistance levels may improve the success rate of the trading strategy. If the RSI is overbought (above 70.0) and the market price is at a resistance level, the chances the price will trader lower are higher. If the RSI is oversold (below 30.0) and the market price is at a support level, the chances of the price trading higher significantly improve.

There is one important rule for support and resistance levels. Once the price breaks below the support level is automatically turns into a resistance level. When the price breaks above the resistance, the resistance instantly  turns into a support level.

Support Level Breakout

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Resistance Level Breakout

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It is also important to note that one a support level is breached the downtrend is expected to continue. When a resistance level is breached the uptrend is expected to resume. A breakout is affirmed when the candlestick closes above the resistance. If you are using an hourly chart the candlestick would close at the end of every round hour. If it is a 15min chart then every 15 minutes (14:00. 14:15,14:30 etc.)  the candlestick would close and a new candlestick would open.

We will use another form of trading strategy, Japanese reversal patterns.

Bearish and Bullish Engulfing

Japanese reversal patterns were used for over 100 years for trading in global markets. We will not clarify the reason behind the reversal pattern in this article but simply show how to recognize it and combine it with the RSI and support/resistance levels.

Bearish Engulfing Example

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 A bearish engulfing is a reversal pattern. It must be painted at the end of an uptrend. When the bearish engulfing has been affirmed this is the moment the price is expected to reverse, trade lower. It is a technical signal indicating of what’s to come. If the RSI is overbought, the price is at a resistance level and the a bearish engulfing has been painted, it is a strong indication the price is due to trade lower, which can be used for trading binary options.

A bullish engulfing is quite the opposite. It forms at the end of a downtrend.

Bullish Engulfing Example

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As you may see, the green candlestick (showing the price has gained) completely covers (engulfs) is preceding candlestick. This is a sign the downtrend may be over. If the RSI is oversold, the price is near a support level and a bullish engulfing has been painted, it is a strong indication the price is due to trade higher.

Shooting Star Example

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A shooting star is a reversal pattern that forms at the end of an uptrend and is a clear warning to the market bulls. A shooting star is recognized when the candlestick closes with a small body (the colour of the body is irrelevant, bearish or bullish) with a long upper shadow.

The actual body of the candlestick must fit at least 3 times inside the shadow to be classified as a shooting star. Combined with the RSI, if it is overbought and a shooting star forms it is a strong indication the price may reverse. If the shooting star forms but not following an uptrend, it is simply a warning the trend may reverse but is insufficient to provide an entry to the market.

In many platforms you will not have candlestick charts to make your analysis. We recommend opening a demo account with Forex brokers and use the charting system from the demo account to place your trades in the market. We prefer making the analysis on the MetaTrader4 (known as the MT4), which is available by most brokers. Many traders trade both spot forex trading and binary options in different platforms.

The above strategies we presented for trading binary options can be used on multiple time frames in the charts, anywhere from 1 minute to the monthly chart. We strongly suggest to avoid an analysis on the 1 minute chart as it may dent the technical signals derived from the market.

The minimum time frame should be 5 minutes and even that is deemed as aggressive by some traders. Once the technical signal has been received from the chart, the expiration must be approximately 3 times the time frame used for the analysis. That means if you used a 5 minute chart and you have a technical signal suggesting the price will rise, the expiration should be at least 15 minutes.  If a daily chart was used then 3 days would be the optimal expiration.

This form of trading is called technical analysis. The alternative is called fundamental analysis, which we will update into this trading guide in due time. Basing your trades before or right after economic figures such as the Non-Farm Payrolls or other employment figures is not fundamental analysis.

If you are new to binary options trading we suggest using technical analysis and simply be aware when there are key economic figures in the market. In this economic calendar all key figures are marked in red.

To conclude, you have very little say in determining when the price will rise or fall as it is derived from the charts. You also have little saying in deciding the expiration as it is also derived from the charts, What you are determining is the amount of capital you wish to invest in the trade, your risk.

We strongly recommend to continue reading the Advanced Binary Options Strategies in which we explain how to perform a healthy risk management in the binary options market and discuss the psychology behind trading binary options.

We will be updating the binary options trading guide with more trading strategies. We hope have assisted you in understanding the binary options market and wish you good luck in your journey.

Last Updated on June 20, 2021