Binary Options are a relatively new form of trading that allows traders to place call or put options depending on their view of the market. We explore the potential for creating a trading system with OptionFire in this article.
If you have read our OptionFire review you will see how simple it is to place trades on their platform. As a binary option means that you either lose or win, with no hold way measures in between, we are investigating the possibilities of building a mechanical trading system to trade with OptionFire.
What Is A Mechanical Trading System?
A mechanical trading system is rules based which means that as long as the rules are followed, there is no room for discretionary decision making when deciding in which direction to trade.
The advantage of having a rules based system is that it can eliminate the impact of emotion – when clearly defined parameters are met, the trader should place the trade, irrespective of his own views or emotions.
This does mean, of course, that considerable work has to be undertaken to develop and fully test the rules before a live trade is placed.
If the trader is to place a trade whenever a signal is generated, ignoring his thoughts and fears, then he has to be highly confident that the rules based system is as good as it can be.
The Systems Based Opportunity With OptionFire
As we explained in our review, OptionFire operate hourly options and you can place trades up to ten minutes before the expiry time at the top of the hour.
To win, if you are predicting the price to increase (call option), the price of the instrument that you are trading has to be higher at the expiry time than your strike price (the price when you placed the trade).
If you think the price will be lower at the expiry time, then you place a put and win if the expiry price is one tick lower, or more, than your strike price.
So we wonder if there is an opportunity to exploit the way in which the hourly options work by developing a mechanical trading system.
The Ten Minute Window
The trader has up to ten minutes before the hourly expiry time to place his trade. Can this be used to increase your win rate with a trading system using trend continuation?
You can see that we are now in the 10 minute trade lockout period in this image:
If your market is in a strong trend as the ten minute cut off approaches, what is the probability that the trend will continue for the next ten minutes?
If the probability is high then a mechanical trading system would dictate that you should place your bet in the direction of that trend.
For example if price is rising in a strong trend then it is likely (but not definite) that price will continue to rise over the next ten minutes so it will be higher than your strike price at the expiry time.
In this case, you should place a call trade because of the likely hood of trend continuation driving price upwards and above your strike price creating a winning trade.
The opposite considerations apply if the trend is down. In which case you place a put and win if the trend continuation drives price below your strike price when the option expires.
Possible Problems With This Approach
While a trend can continue for a considerable time, you must consider these factors:
Pullbacks or retracements within the trend:
Price never follows a trend in a straight line. There are pullbacks and retracements as traders take profits or make bad decisions. You could encounter a pullback or retracement during the ten minute window that moves the price against your trade.
Trends do not go on for ever and they can peter out as market participants do not enter new positions in direction of the prevailing trend. You could experience trend exhaustion during the ten minute window which goes against your trade.
Markets such as crude oil have high volatilities in which price moves up or down by large amounts even during an established trend. This volatility could go against your trade, even if the trend has continued in your predicted direction.
Final Thoughts And A Warning
We have presented a possible foundation on which to build a mechanical trading system to trade hourly options with OptionFire, in this article.
A possible window of opportunity has been identified in which a trend following system could be used to increase the chances of placing winning trades.
This will be explored further in future articles, but please note that this is a theoretical discussion designed to help you, the reader, to think about your own trading system ideas.
There is nothing in this article that should be construed as giving trading advice or offering trading recommendations.
Binary Options are risky and you should make your own decisions about when to trade and how much capital to put at risk.