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Hedging a Breakout Failure with Binary Options

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Although Binary Options trading by nature is already risk controlled because you as a trader never lose more than your initial investment amount, there is an easy way to minimize your loss in the event you chose the wrong direction: it is called hedging breakout failures.

The strategy is simple:

It is 30 minutes into the hour trading window. You have 20 minutes left to execute a trade (remember, the last 10 minutes are closed to trading). You want to choose your position, for example, a CALL or a PUT at the current strike price $100. You recognize a breakout and you want to speculate that the instrument’s price will continue in that direction by placing a Binary Option CALL or PUT trade, depending on the direction of the breakout. If the instrument continues to move in the direction you speculated at the moment you placed your trade, should the hour close you would have a successful trade. However, the hour is not yet closed and suddenly you see that the instrument’s price begins to change direction. The moment it reaches back to $100 (your strike position when you made your trade) is the moment when you need to act to hedge your breakout failure. You know that if the instrument’s price continues past $100, you will have lost your trade, and thus your full investment amount. There is still 5 minutes left to execute your trade, and so you place a trade in the opposite direction (if you had placed a CALL then now you place a PUT) when the instrument’s price is at $100. Note that you must execute the trade as close to the price that the breakout occurs. In this case you have hedged your trade and “insured” your position. If you had hedged your bet as close as possible to when the breakout fails, you will see the benefits of hedging to minimize your loss.

To put the same example into dollar terms, let’s say you placed your trade at the instrument price of $100 for an invested amount of $100. You would have lost your full invested amount of $100 had you not decided to hedge your trade. Since you acted proactively, you then placed your opposite trade (hedge), also for $100, at the breakout failure point. You invested overall $200, but you got $185 back instead of $100 had you not placed your hedge. Your total loss then, instead of $100, is only $15. Using this hedging strategy, if you are right only 50% of the time then you will make a steady 70$ per game on average (85$ when you are right, – $15 when you are wrong).

And that’s it. Simple, straightforward, and smart to do define what encompasses hedging breakout failures in Binary Options trading.

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4 Comments on this post

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  1. igz said:

    correct your diagramm, it has the the same text for Put and Call description.

    February 4th, 2011 at 8:57 am
  2. Michael Greenberg said:

    good catch they are fixing it now

    February 4th, 2011 at 9:20 am
  3. Michael Greenberg said:

    done

    February 4th, 2011 at 9:26 am
  4. Trader said:

    The problem is, of course, that it’s not that simple.

    IF you can “tell that a breakout is in progress” (be it one that ultimately succeeds, or one that ends up failing), and if you can with a high confidence enter your CALL before the price has jumped, without price coming back *immediately*, then you could profit from it on spot Forex as well: just buy and sell a bit later when the break-out attempt is still in progress, without waiting whether the breakout succeeds ultimately.

    If on the other hand it’s a fake breakout, price could come back very quickly – at which point you’d have to accurately hedge (hard with this manual options platform) plus you’d have to decide whether it’s truly a failed breakout, not just a pullback and a test of the resistence-turned-support price line … and price often goes back to the break-out point so you really have no idea whether to hedge or not, until it’s late …

    In hindsight it’s very easy to tell whether a breakout was fake or not. In advance it’s hard to get in at the right moment though: and options do not improve this fundamental problem in any way.

    So there’s no “statistical edge” in binary options for any strategy, mathematically – binary options are spot forex derivatives.

    The difference is the trading platform and the risk psychology: if trading binary options is more intuitive and less stressful to you then by all means go for it – but do not for a minute assume that it gives you any inherent edge statistically.

    Remember, in Forex there’s no free money …

    February 4th, 2011 at 10:30 am

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