By Darrell Martin
New traders often choose a cheap binary option assuming they can risk five dollars to make ninety-five. They look at the binary ladder chart and decide that it 1) looks like a great risk and 2) they can afford to lose five dollars. Sure, it all sounds great. Who doesn’t want that type of return? Risk $5 and make $95. It all sounds wonderful. They place the order and then complain when they lose the $5 saying that trading binaries does not work.
You can’t just look at the cost or the risk of the binary. You have to understand its low price. Look at the mid-price as the probability. The mid-price is the average of the bid and the offer prices. For example, if you are looking at buying a $5 contract and the bid is zero, the mid-price would be 2.5, giving you a 2.5 percent probability of winning.
There are certain circumstances where the low-priced contracts are beneficial. You have to know the market and its expectations in order to use them in your trades. Keep in mind the low-price contracts have a low price because they have a lower probability of winning. The market has to move a great deal for them to become profitable.
A binary is simply a true or false statement. You are saying that at expiration, either yes, the statement will be true, or no, it will be false.
The cheap binaries are out of the money (OTM). Higher priced contracts already have true statements. The market is already in the money (ITM). As long as the market continues to move up, stays flat or even moves down, but stays above the strike, the binary is still true and profitable. There is more risk to enter the trade, but they have a much higher probability of being profitable. An at the money (ATM) contract is when the market is trading right at the strike price. It has a 50/50 chance of being profitable. It doesn’t matter the amount of time left in the contract.
Train your eye to first look at the indicative price and then find the ATM strike. After that, you can figure out which strike would be the best binary for your trade. Remember, a strike close to the market price will be priced around 50.
Check the probability. You may not like the max loss if you buy a higher risk contract for 70, but you can keep your risk low. If you buy a contract for $70 and the market moves against you, exit when the market hits your strike. The contract will be worth approximately $50 bringing your risk down to $20. Trading with Nadex makes this option possible, as you can exit your trade at any time provided there is an opposing side available at that price.
This strategy to limit your risk does require discipline. There may be times when you exit the trade when it hits your strike and then goes back in the desired direction. This can cause frustration and make you think that you might not have lost the $20. An account can handle losing $20 several times compared to losing $70 several times.
Buying cheap or OTM binaries are ideal with certain strategies, but not for beginning traders to think for every trade they are the low-risk, high-reward way to trade. Take time for demo trading and education.
Nadex Risk Disclaimer · Trading on Nadex involves financial risk and may not be appropriate for all investors. The information presented here is for information and educational purposes only and should not be considered an offer or solicitation to buy or sell any financial instrument on Nadex or elsewhere. Any trading decisions that you make are solely your responsibility. Past performance is not indicative of future results. Nadex instruments include forex, stock indexes, commodity futures, and economic events. · Nadex binary options and spreads can be volatile and investors risk losing their investment on any given transaction. However, the limited-risk nature of Nadex contracts ensures investors cannot lose more than the cost to enter the transaction. Nadex is subject to U.S. regulatory oversight by the CFTC.