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The main disadvantage of binary options is negative expectation. Those. when you lose, you always lose more than when you win. Can this be improved? Or even create situations in which you double your winnings? Doing it many times the potential loss?
Yes, this is possible. The key to success is hedging trades .
Required% of profitable trades
Trading in financial markets is almost always a game with negative mathematical expectation. The only exceptions are rare arbitration situations. That is, when making transactions on the exchange, the risk of losing part of the funds is always greater than the probability of making a profit. This is due to the fact that when you buy a contract, you always pay a certain commission, therefore, when you open a position, you are already at a small loss. This statement is also true for binary options : if you win, you always get less than you lose if you lose.
Let it be that the percentage of payments set by the broker is 80%. Then, the percentage of winning trades should be: 100% / (100% + 80%) = 56% . That is, more than half of the trades should be with a positive outcome, so as not to simply be in the negative. And in order to stay in the money, in a series of 10 trades, it is advisable to have no more than three unprofitable ones. And this with a fairly high percentage of payments!
To reduce the influence of trading costs on the final financial result, traders use various strategies to minimize risks. One of the most common and effective risk mitigation strategies is the hedging strategy, which is designed to insure you against possible losses. At the same time, the result of using such a strategy may be a decrease in potential profit, since profit is inversely dependent on risk. But, sometimes such a strategy also allows you to get double profit from the transaction.
Methods of hedging binary options
It is important to understand that hedging is more a kind of money management system than a trading strategy on its own. The decision to enter a trade should be made by a separate strategy, preferably with a high percentage of winning trades (more than 60%).
Consider the possible outcomes when hedging binary options:
Out-of-The-Money (OTM) is an option that, if the price is immediately exercised, will bring a fixed loss. In this case, if the Call option is purchased, the current price must be below the strike price. For a Put option, the situation is the opposite, the current price must be above the strike price. If the difference between the current price and the strike price is large enough, the option is said to be deep OTM (deep at a loss).
Despite the fact that most novice traders use hedging precisely on unprofitable positions, the best solution in this situation would be to psychologically accept losses and fix the loss. Now you will understand why.
Let’s say we bought a Put option worth $ 10, but after a while the market situation changed and the previous goals lost their relevance. At the same time, the price turned around and started moving in the opposite direction. A typical decision in this case would be to buy an additional $ 10 Call option at the top. However, this approach does not work for binary options and is deliberately false, since this creates a double loss zone, where we lose the value of both contracts. That is, instead of reducing potential losses, we increased them.
At-The-Money (ATM) is an option that, if exercised immediately, leads to a zero result. This happens when the current price of the instrument equals the strike price. This is a rather rare situation in the market, since it is far from always possible to open a deal at exactly the same price.
We bought a Put option, but suddenly the picture on the market changed, and the price, having turned around, breaks through the resistance level. Since the price has already broken through the key level, it would be best in this situation to wait for the confirmation of the support level – touching the line on the other side. Once the price has touched the level – buy Call-option of the same size and term expiration . The presence of a Call option at this level creates a breakeven zone and the result of the execution of both contracts is zero, minus trading costs.
In-The-Money (ITM) is an option that, if exercised immediately, leads to a positive result. A call option is in the money when the instrument price is above the strike price. In the case of a Put option, the price must be below the strike price. If the price has gone far, it is usually said that the option is deep ITM (deep in the money).
For the strategy to work, you must find the maximum trading period and buy a Put option. Then, find the minimum of the trading period and buy the Call option. The biggest challenge lies in finding the very maximum and minimum. Ideally, the price should move in a symmetrical channel, then you only need to open deals on time from the boundaries of the formed channel. If the volatility of the instrument is not too high, the chance of unpredictable development practically disappears.
When receiving a signal to enter, buy a Call option. The price moves in our direction and when the opposite border of the channel is reached, we buy a Put binary option of the same size and expiration time. The beauty of this solution is that there is no way you can fail. In whatever direction the price goes, both contracts are “in the money”. Basically, the chart is divided into two zones: a breakeven zone and a double profit zone, where both trades win.
Hedging Trading Rules
- The trading strategy gives a signal to enter;
- Choose the required investment amount, expiration period and buy a Put or Call option;
- The price has gone in the right direction and there is still enough time left before the expiration date. At the same time, the trading strategy gives a new signal opposite to the first one. The reasons can be completely different: weakening of the current trend, the appearance of a strong resistance or support level, or other reasons associated with the signals of your trading system;
- We buy the option opposite to the first one. At the same time, we choose the expiration time equal to the first deal. That is, for the strategy to work correctly, both options must be executed at the same time;
- We are waiting for the onset of the option exercise.
Let’s look at the first example on the four-hour EURGBP chart . As you can see, on the chart we have a price moving in a sideways channel and two levels: a resistance level and a support level. When the price touches the resistance line, we buy a Put option. After the price went down and touched the opposite channel line, buy a Call option of the same size. After the expiration of both contracts, the price remained within the designated range and we got a double profit.
Another example on a 5 minute chart. The price broke through the support level and we bought a Put option with an expiration time of 4 hours. However, having passed some distance, the price unexpectedly found a new support level and began to move in the opposite direction. After that, the price once bounced off the resistance level, and broke it out on the second attempt. In this case, we waited for a second confirmation – touching the key level and bought another Call option, with an expiration time equal to the first deal. As a result, the first option was closed with a loss, and on the second we got a profit.
As you can see, hedging is a great way to minimize the risks of binary options trading. Unlike the same forex , the use of hedging on binary options opens up new opportunities for the trader and, at times, allows you to get double profits. This strategy works equally well for short-term and long-term options. The only thing, when buying options for short periods, make sure that your broker allows you to flexibly adjust the expiration time. This is a critical strategic point. Also, use proven trading strategies with a win rate of more than 60% in trading, then hedging will be as effective as possible.