Profitable Binary Options Strategy using the Stochastic Oscillator

All successful trading systems or strategies use a predefined set of trading rules to generate objective buy and sell signals. For binary options traders, the variety of trading strategies is almost limitless; however, the most profitable systems have a number of elements in common which maximize the chances of success.

High Probability Setup

A profitable trading strategy must have a high probability setup. That is, when a trader feels a trade (or trade direction) has a very good chance of success. To a liberal trader, a high probability trade is one which is successful two out of three times. To a conservative trader, the success rate is four out of five times. To identify a trade as being high in probability, a trader will primarily look at a security’s price history and back test the theory to statistically evaluate the strategies profitability and market success.

Risk to Reward

For binary traders, a profitable strategy must have a high win ratio. Depending on the strategies correct analysis of the market and the pre-determined payout percentage from the broker, a binary options trader can expect 60-85% on a winning ‘in-the-money’ trade or 100% loss for an ‘out-of-the-money’ trade. This means a high win ratio of at least 6 wins out of 10 trades is essential to the trader for profit.

Trading Opportunity

For a strategy to be considered profitable there must be opportunities to trade. A traders’ profit can be limited by low numbers of potential trade setups therefore a profitable strategy must offer reliable but (semi) regular buy and sell signals.

Market Direction

Because binary options traders are not concerned with how much an asset moves in price, only direction, a profitable strategy must offer clear market direction signals to ensure the trade expires ‘in-the-money’. The trader of a ‘call’ option will be of the view that the market will move in an upward direction. Conversely, the trader of a ‘put’ option anticipates the market will move in a downward direction.

Technical Indicators

Technical indicators such as Moving Averages, Commodity Channel Index, Williams Accumulation/Distribution etc, are mathematically based trading tools which traders use to analyse past price trends (lagging indicator) and predict future price patterns (leading indicator). As opposed to fundamentals traders who use economic reports and indicators to interpret the market, technical traders utilise indicators to identify profitable trading opportunities. Typically, technical indicators include signal filters and triggers which form the basis of most trading strategies.

Stochastic Oscillator

The Stochastic Oscillator is a momentum indicator that compares the stock’s price to its price range over a certain period. In an upward trending market, the stock’s price usually closes at or near the high. During a downward trending market, the stock’s price usually closes at or near the low. Plotted on a sub-chart below the main price chart with a range of zero and 100, the Stochastic Oscillator is displayed as two lines. The main line is called %K, displays the current close in relation to the period’s high/low range. The second line, called %D, is a Moving Average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line.

The Stochastic Oscillator is an important indicator of oversold and overbought levels. Oscillator readings below 20 are considered oversold whereby selling pressure has taken the stock’s closing price to below its true value (undervalued) and a price correction to ‘typical’ price – or a significant bullish reaction (a reversal) is anticipated.

Oscillator readings above 80 are considered overbought whereby buying pressure has taken the stock’s closing price to above its true value (overvalued) and a price correction to ‘typical’ price – or a significant bearish reaction (a reversal), is anticipated.
Typically, the Stochastic Oscillator is based on 14 periods, which can be days, weeks, months or an intraday timeframe.

Stochastic Oscillator: Profitable Trading Strategy

The Stochastic Oscillator is a reliable and effective indictor which, when used as a trading strategy, generates profitable returns. Considered a leading indicator (predictive in nature), the Stochastic Oscillator generates buy (call) and sell (put) trades at key price reversal points signalling overbought and oversold levels.

A buy (or call) signal is generated when the Stochastic Oscillator crosses below 20 and the %K line crosses over the %D line. Indicating that the current price is 20% above the lowest low of the last 14 days and 80% below the highest high and therefore nearing its inter-period low, a Stochastic Oscillator value of 20 is considered an oversold marker. At the oversold level (20), selling pressure has taken the stock’s closing price to below its true value (undervalued) and a price correction to ‘typical’ price – or a significant bullish reaction (a reversal), is anticipated.

A sell (or put) signal is generated when the Stochastoc Oscillator crosses below 80 and the %K line crosses below the %D line. Indicating that the current price is 80% above the lowest low of the last 14 days and 20% below the highest high and therefore nearing its inter-period high, a Stochastic Oscillator value of 80 is considered and overbought marker. An the overbought level (80), buying pressure has taken the stock’s closing price to above its true value (overvalued) and a price correction to ‘typical’ price – or a significant bearish reaction (a reversal), is anticipated.

Trader Note
Responsible money management ensures that the losses don’t mitigate the profits.