What is the spread?
The spread is the potential profit for the broker, much like the casino in a game of blackjack. The spread means that you the trader need to develop a trading system with an advantage, meaning more than 50% of your trades are successful in order to beat the spread. For a binary options trade with a 75% payout, you need 57% success rate on these trades in order to beat the spread. With a little bit of skill and experience, it is easy to develop a profitable trading strategy that consistently beats the spread.
In any successful trading strategy it is important to have a series of trades in your trading toolbelt that you can use. Within your binary options trading strategy, you want to be able to look for the right tool to fit the current asset and market conditions. Your trading tools will help you figure out what to trade, when, and in what direction. Some traders focus on one style of analysis, for example fundamental analysis or technical analysis. Other traders use combinations of styles to make money. You have to develop your own trading style. If you need some help getting started to develop your strategy, watch our video on charting where we talked about some basic technical trades that you can try. Or see some of our more fundamental trading strategies in later videos. Regardless of your style, you will need to develop a few different tools for your toolbelt. That way, you can always choose the right tool for the job. But first you need to develop each tool, or each play.
Some traders are very formal and create a document that lists all of their successful trading strategies. I recommend keeping some sort of document, particularly if you are new to trading because it helps you remember what you did right (and wrong).
This way, you can learn as you go. Start by listing the ideas that you have. Typically you want to focus on an asset class (such as stocks, commodities, or currencies).
Over time, you might develop trading strategies for each asset class but we usually do them one at a time. Within an asset class you will probably focus on certain securities or assets. Within currencies, you might stick to G7 currency pairs, or pairs that contain your home currency. Or, you might have just a short list of pairs (5 or so) that you follow and know very well. All of this information goes in your document as part of your strategy. You might even have a framework for trading each asset during the day. For example, certain times are key for certain currencies, such as economic data announcements that come out of the US at 8:30am eastern time. These announcements can move USD versus a number of different pairs. You want to make sure you know the schedule of announcements so you are not caught off guard with a big move. Your document then should list the idea for each trade.
Here you want to be as specific as possible, detailing the underlying asset, what to buy (calls or puts), at what time (or under what circumstances), for what expiration.
Even if you don’t know right away what is the best strike price or expiration, write down what you think and then try it with some small trades. When you put real money in your trades you will learn quickly what works and what doesn’t. You can learn from successful trades and wrong trades too. Each time you do a trade, do a “post-mortem” if you can where you look at what you did and why, and the outcome. It is possible to do everything right and still be wrong sometimes, but you want to increase your winning percentage as much as possible. Your post-mortem analysis will help prevent making the same mistake over and over again.
Diversification and Capital
Your strategy should also include a framework for how much capital to commit to each trade. This will reduce the temptation to make risky bets with significant amounts of your capital. Remember, you can’t be right all the time. Your strategy may include a framework for allocating more capital (or less) to some trades, but you want to be as disciplined as possible about sticking to your strategy because this is how you will make money consistently over time. When we talked about diversification, we talked about 20 trades at a time. I like this number because it allows you to spread out your risk. If you lose money, each trade is only 5% of your capital at risk. You may find that you can handle more trades, or that you need to focus on fewer trades depending on how much analysis is required for each trade.
You also may find that initially you prefer to spend more time on each trade, but as you gain confidence you can spread out and trade more positions at once.
Trading Strategy Spreadsheet
You may want to keep a spreadsheet of your trading positions. Keep track of the underlying asset, asset class, strike price, entry time, expiration time, and direction. This will help you track successes and failures, and will also let you analyze your strategy over time. You may find that you have more success with your strategy on certain underlying assets, or in predicting up-moves relative to down-moves. A spreadsheet will help you figure that out.
Once you have your document and spreadsheet set up, you will see just how easy it can be to develop a winning trading strategy for binary options. Even though the broker spreads mean you need to be right more than 50% of the time, you can do that consistently and make money trading binary options over time.