Strategies to trade Digital Options
In the world of finance there is nothing more important than a plan. Sticking to the plan is what differentiates the beginner from the pro. Companies and big firms all have financial plans in form of budgets, forecasts and other written documents. Instead of a trading plan, we could refer to this also as a trading strategy. A good trading strategy must be verifiable, quantifiable, consistent and objective.
In one sentence: gut feeling and hoping for the best is NOT strategy. That puts your trading at the same level as gambling and will lead to a disaster. In order to be verifiable, a strategy must be tested. Historic price charts will help to assess, whether the strategy would have worked in the past and how profitable it would be. One very important aspect is to know the Win-to-Loss-Ratio. With simple words: Nobody is right all the time about everything. Failures, errors, losses – they will all occur at a certain time and in a certain form. The great question is: how long will you be able to withstand a losing streak? How big is every loss in terms of money? Does your strategy allow to recoup the string of losses that – no doubt – WILL occur?
These are all questions that will need answers, before you click that mouse button and put your hard earned cash on the line. This is a business, not some computer game. Treat it as such and you will be rewarded. Disrespect these simple “rules of engagement” and you will lose lots of money very quickly. Frustration is ensured. With all this said, let us consider a possible trading strategy for Digital Options.
The first question that needs to be answered is: what expiry time will you trade? We recommend a 60-Minute approach. Shorter time intervals are very difficult to trade and often tendencies or trends are not really visible or remarkable. Trends exist at all time intervals! They are only very difficult to detect by the novice. Consider this like a small stream in a river, that will eventually lead to a big stream or a waterfall, which finally ends in the sea – where the current is obvious. If you look at this from a birds eye-view, then the direction, strength and presence of the stream is clearer if you are closer to the sea (=bigger timeframe). If you are miles away from the sea, than the stream will be bearably noticeable.
Now you have to decide if you will trade Indices, Currencies, Commodities or Stocks. We don’t have preferences. They are all asset classes with profit potential. Use something that suits you and your level of knowledge. One advantage of currencies is, that the “market never sleeps”. This will give you more trading opportunities and also more liquidity to catch some good trends. Some stocks barely move in hours or days! This makes a good assessment much more difficult. We want to keep things nice and easy here.
So, we now have 60-Minutes expiry times and let’s say, the EURUSD currency pair. The reason why we are mentioning this pair is, because 70% of the world’s transactions are still being made in US-Dollars. So, there is a pretty good chance that this pair WILL move in either one of the directions, within your scheduled trading times (the time you are available to sit in front of the computer to trade). This is very important. If you are currently living in Japan, but want to trade French stocks, then you have to wake up in the middle of the night to catch some of the best movements. That is not to say, that you can trade anything you want and any time you want. We are just trying to be smart here.
The next step is to determine your trading size. How much money will you commit to one single trade? Consider the scenario of losing 6 trades in a row. This is not uncommon and actually a pretty realistic win: loss-ratio. 60% of the trades failing and only 40% of the trades winning. The 40% have to cover the losses of the 60% and still give you a profit! This is how you should calculate. If you have 100 USD/EUROS/POUNDS to trade, then this means you can only trade with sizes of 10 USD/EUROS/POUNDS. If you lose 6 trades in a row, you will still have 40 in your account to catch up and make a profit.
At this point it is difficult to determine if your – or our – strategy will be in the range of 60:40 or 70:30 or 50:50. This will depend on many factors. The payout ratio of the broker is a VERY important factor. If the broker pays you only 65% or 75% for any single winner, but takes 100% for the losers, then a 60:40-ratio will break you. This is a fine balance between Payout ratios and Win-to-Loss-Ratios. There are formulas to determine the probability of the Win-to-Loss-Ratio, but we will consider these in another article.
For now it is important for you to know, that there are a few basic decisions to make. We considered the expiry time, the asset class, the position size and briefly touched on the subject of Win-to-Loss-Ratios. All these things are part of a good Digital Options trading strategy. There are many other decisions to be made, but for now we will leave it at this. In our next article we will discuss the mechanics of a possible strategy and see how this fits with the aforementioned discussion. Stay tuned to more valuable content from ForexTradingCircle. We want you to succeed and are here to help you with your trading needs and questions. Feel free to contact us through our website.