Consider the following bets:
Welcome to binary options. All or nothing, one or zero, these securities are available on Nadex and the Chicago Board Options Exchange (CBOE). Binary options allow traders to make time-bound conditional bets on predefined values of stock indices, forex, commodities, events, and even bitcoin values. Like a standard exchange-traded option, each binary option has an option premium ($45, $81, $77, and $33 in the examples above), a pre-determined strike price ($1,250, $2,244, 78.06, $379.5), and an expiry (1:30 p.m., 2 p.m., 3 p.m. today).
The differentiator is the settlement price that remains fixed at $0 or $100, depending on the option condition being fulfilled. It keeps the net profit (or loss) fixed. The option premium also remains between $0 and $100. (Related: Guide to trading binary options)
Since binary options are time-bound and condition-based, probability calculations play an important part in valuing these options. It all boils down to “what is the probability that current gold price of $1,220 will move to $1,250 or above in the next four hours?“ The determining factors include:
Technical indicators suitable for binary options trading should incorporate the above factors. One can take a binary option position based on spotting continued momentum or trend reversal patterns. Let’s look at some of the popular binary option technical indicators:
Position |
Momentum |
ADX Value > 25 |
ADX Value < 25 |
DI+ above DI- |
Indicates Uptrend |
Strong Uptrend |
Weak, Unsustainable Uptrend |
DI- above DI+ |
Indicates Downtrend |
Strong Downtrend |
Weak, Unsustainable Downtrend |
Here is an illustration, using 3M Company (MMM) stock:
Image courtesy StockCharts.com
Depending upon the identified momentum and trend strength, an appropriate buy/sell position could be taken.
"Price" is the asset's current price, "MA" is the moving average of the asset's price, and "D" is the normal deviation from that average.
High values above +100 indicate the start of a strong uptrend. While values below -100 indicate the start of a strong downtrend.
The crossover of %K and %D values indicate trade entry signals. Although a 14-day period is standard, binary option traders can use their own desired timeframes.
Levels above 80 indicate overbought, while those below 20 indicate oversold.
Commonly followed values are 12 for simple moving average and two for a standard deviation for top and bottom bands.
Contraction and expansion of the bands indicate reversal signals that help traders take appropriate positions in binary options. Overbought situations are indicated if the current market price (CMP) is above the top band. While overselling is indicated when the CMP is lower than the lower band.
A challenge in binary option trading is correctly predicting the sustainability of a trend over a given period. For example, a trader may take the right position for an index, predicting it would hit 1250 at the end of a five-hour period, but the level was achieved in the first two hours. Constant monitoring is needed for the rest of the three hours if the trader plans to hold the position until expiry, or a predetermined strategy should be executed (like squaring off the position) once the level is reached.
The Bottom Line:
The technical indicators discussed above should be used for timely actions with constant monitoring. One major disadvantage with technical indicators is that the results and calculations are based on past data and can generate false signals. Traders should practice caution with detailed backtesting and thorough analysis for high-risk, high-return assets like binary options.