The most popular trading strategy discussed when it comes to trading binary options is trend following. Traders and Brokers like to toss around the phrase “The trend is your friend” or “Never fight the trend”.
To properly apply the trend following strategy a traders must first know how to find the trend.
Below are three charts.
When looking at the first chart, you will notice that the trend is going down. When you look at the middle chart, it doesn’t really show a trend except choppy trading. The last chart shows a V shape.
When you open your trading platform, depending on the broker you are trading with, it will show a different time frame than the pictures above.
Reading a chart of the wrong time frame will cause a trader to make the wrong trade.
For instance in the first chart of Oil above. We can see that in the past three months, almost every day the price of oil went lower. If we remove all the news and sentiment that we personally feel about the value of a barrel of Oil and only focus on price movement, it is very obvious that the price of oil is going lower. A true trend follower will short / buy puts on Oil in the anticipation of the trend continuing.
But when will the price move lower? Based on the first chart, the price should move lower sometime in the next month.
The biggest mistake would be to buy a put on Oil that expires in one hour or one week!
Now lets analyze the last chart. The 5 minute price of Oil.
There are a few ways to trade on a V shaped chart, but let’s stick with the trend following mindset for this trade.
As the morning started, Oil started trading lower. A day trader will look at the chart and make one of two calls.
- Oil is moving lower and that means at the end of the day Oil will close down on the day. That trader would buy a put with an end day expiration.
- Oil is currently moving lower, so the trader buys a put that expires in one hour.
Looking back at the end of the day, the profitable trade was the one that was only for a one hour time frame.
Digging deeper into the chart. If we look at the large drop in prices at 1:40 PM, a trader that buys a 5 minute PUT will have lost money as the price recovered and moved up between 1:45 & 1:55.
To summarize: Trend following is the basic binary options trading strategy, yet if the trader reads the wrong chart time frame, or picks the wrong option expiration, the trade turns into a loser.