Today we will look at some methods of using traditional trend lines in new ways. The 30-minute bar chart below shows an example with some simple trend lines on the USD/JPY forex currency pair during the last week of trading. The grey lines show two sets of simple trend lines; within the outer set is an inner set of lines that is just about 15 pips apart now.
The pattern of these closer trend lines are sometimes referred to as a pennant formation, since the geometry takes a shape similar to its name. What a pennant formation suggests is that price has been consolidating for a period of time, is about to be squeezed out of this pennant, and will soon begin to trend.
Using these types of trend lines is one of the oldest and simplest ways of looking at technical analysis. However, traders can find new ways to trade these traditional patterns by using binary options. At the time of this writing, it is just after 7:00 am EST in the United States. Perhaps you would be preparing to go to work at this time and wouldn’t have time to wait to see which direction this market breaks out; or it may be that you are getting ready to trade, but you know that the market often experiences false breaks and reversals.
In either case, binary trading offers something different for you. If you were trading traditional forex you would have to be long, short, or flat; but with binary options you can trade the expectation of a breakout in either direction. When entering a trade with binary options, you always know your risk and your expected reward, which would be realized if price closes above or below a strike price at a specific time, or expiration. These options are CFTC-regulated and have a $100 base value per contract at expiration.
Please keep in mind as we go over this example that this article is not a recommendation of a market direction or even of a specific strategy, just an educational presentation demonstrating one of the many ways binary options trades may be implemented.
We will use the example of the pennant formation above to show an example of a binary option trade. Since the pennant can indicate that the market is about to break out in either direction, if you want a trade that could be profitable no matter which way this market trades, you could trade two what is known as a strangle. This would involve trading two binary options – buying one and selling the other.
When buying a binary option, you need the market to close above the option’s strike price; and the risk is limited to the purchase, amount while the potential reward would be the difference between the risk and the $100 payout. When selling a binary option, the reverse is true – you want price to settle below the strike; and your potential reward is the options selling amount, while the risk would be the difference between that sale price and the $100 payout at expiration. When trading a strangle, the overall risk would be the combined risk of the two options, and the potential reward would be the profitable leg minus the unprofitable leg.