Binary Options: Skills and Tools to Trade Them

binary trading

Trading binary options requires three essential skills. The first is to correctly gauge the direction of the underlying security. The second is to correctly gauge the strength of the directional trend of the underlying security. And the third is to correctly compute the true odds of the underlying security reaching or not reaching the strike price. All of these require understanding basic arithmetic.

The Underlying Security’s Direction

“The trend is your friend” is a popular Wall Street saying that is even more true for binary options. This is the most easily understood skill. If someone buys a binary option on Google and the stock price turns down, their prospects for ending up in the money are poor.

The Strength of the Underlying Security’s Trend

It does the trader no good to be correct on the underlying security’s trend if it still falls short of the option strike price. For example, a trader believes a stock is going up to $10 soon even though the market price is $8, so they buy a binary option with a strike price of $10. At expiry, the stock’s market price has gone up to $9. Therefore, the trader receives $0. They were correct about the direction of the trend, but overestimated its strength. They lost money just as though they were wrong about the trend’s direction.

Compute the Underlying Security’s True Odds of Reaching the Strike Price

A trader believes the underlying security has a 50 percent chance of reaching the strike price. However, the binary option’s market price is $75. That means, in effect, the market believes the security has a 75 percent chance of reaching the strike price. If that trader buys at that price, they are accepting a poor return for their investment. If the security does reach strike, they receive $100, but that’s only a $25 profit. If they truly won despite beating 50/50 odds, they should receive twice what they paid for the binary option. Every time a trader buys or sells a binary option, they are matching wits with the marketplace. They will sometimes lose, so when they win they must receive full compensation for the odds they had to overcome.

Binary Options Trading Tools

The Nadex Exchange is the main platform for trading binary options in the United States. They do supply the tools a binary options trader needs. That is, traders need access to real time securities prices, charts and the prices for the binary options available. And they need a database of historical price data.

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