What is the best strategy for trading flat markets?
Trading flat markets is tricky. On the surface, it can seem like there’s little point in taking a position when there’s no volatility to create opportunities.
If you’re searching for ways to trade flat markets, you may want to consider binary option contracts. These handy contracts are simple, no nonsense, and can create interesting opportunities in situations where other financial products might not deliver – especially in markets with little volatility. Here, you can learn how to turn flat market conditions to your advantage.
What is a flat market?
A flat market is one where there is little price movement; the market typically trades within a tight range, rather than forming a clear up or down trend. Charts showing flat markets have few peaks or dips and appear relatively boring.
Flat markets occur for many reasons – investors may be losing interest, or there could simply be few financial events affecting the market at that particular time. As an example, flat markets may occur for hours or days prior to a scheduled economic event, as traders are hesitant to pick up too much exposure in either direction.
Can I profit in a flat market with binary options trading?
It is possible to profit in flat market conditions using binary option contracts, as long as you look for the right strikes and pick the correct strategy for trading low volatility levels. In fact, the opportunity to profit in flat markets largely comes from predicting that a market will remain flat.
When you have analyzed the markets in an attempt to proactively recognize future market movements, you can utilize this knowledge to trade in flat markets. What matters when trading binary option contracts isn’t the size of the market movement (in this case, we are expecting almost no movement), but that your prediction is correct.
One of the most unique aspects of a binary option contract is the time value, and the fact that it will either expire at zero or 100. This means that even if a market doesn’t move at all, the price of the binary option will still drift toward either the floor or the ceiling as time erodes.
In the case of ITM binary options, if the market doesn’t move and time erodes, they will move to 100, the best possible outcome for the buyers.
For OTM binary options, if the market doesn’t move, they will move to 0, the best possible outcome for the sellers. Of course, depending on the duration of your contract, this can happen over the course of a day, an hour, or even in a few minutes.
Best strategies for trading flat markets
If you want to give yourself the best risk-to-reward ratio possible, you can trade using particular strategies to try to increase your probability of success. These are the main strategies that may be able to help when trading a market that has low volatility. Learn more about them, their uses, and how to execute them.
A flat market doesn’t necessarily have to move sideways – it can still fluctuate, but the peaks and troughs will occur within a set, typically smaller, range. Previous highs and lows are repeated, rather than a new trend being defined. This is where boundary trading, also known as range trading, can be most effective.
The practice involves drawing lines on a chart to track highs and lows, which can be very useful when defining boundaries and working out the patterns the market is most likely to follow. Support and resistance levels become stronger each time these boundaries are tested, so you can get a good idea of a market’s range.
You can apply various technical indicators to your charts on Nadex to show support and resistance levels. Find out more about technical indicators, charts, and how to use them when trading binary option contracts.
Variation on a condor spread
The idea of range trading can be taken further and developed into a full strategy for trading flat markets. This one is similar to a premium collection options strategy and is essentially a variation on a condor spread. It is most effectively applied to markets that are experiencing very little movement, as these give the best risk-to-reward ratio.
This trade is carried out in one or two legs – here’s how it works:
This is the simplest way to execute the strategy. You buy an in-the-money (ITM) contract (one where the market is already above the strike). When buying, you are predicting the market won’t move below the strike before expiration. You could also sell an out-of-the-money (OTM) contract (one where the market is below the strike).
By selling, you are predicting this will remain the same and the market won’t move above the strike before expiration. This can be a good strategy for trading flat markets because it’s less likely that the contracts will move significantly above or below the strike – if they stay where you think they will, the contract will expire in favor of your position.
The maximum risk will outweigh the potential reward, however there is a higher probability of the trade expiring at 100. The reason for this is probability. When executing this trade, you are attempting to put the probability of a positive outcome in your favor. In this respect, you are giving up some potential return for a higher likelihood of a successful trade.
Because of this dynamic though, this is the type of trade where it can be very important that if it starts to go against you, you may want to consider closing out of the position and taking a far smaller loss than the maximum possible.
This is a variation on the previous strategy, which involves buying and selling on the same market. It also gives you the chance to potentially make a higher profit when trading in a flat market. To execute this strategy, you would buy one binary option contract that’s ITM and sell one that’s OTM. If one side is wrong, the other will likely be right, so it creates a more favorable risk-to-reward ratio. Here’s an example to illustrate this:
You decide to trade binary option contracts based on the EUR/USD. You think that the market movements will be very small and will stay within a certain range (more than 1.1122 and less than 1.1135), so you decide to try and capitalize on this by buying and selling. To set up the trade, you buy a contract with a strike that’s priced around $70: > 1.1100. You then sell a contract with a strike that’s priced around $30: >1.1140.
This means you think the following: EUR/USD will be above 1.1100 at expiration but will be below 1.1140.
Risk and reward
Buying one contract at $70 and selling one contract at $30 equals a total cost of $140. The risk for each leg individually is $70, for a combined maximum risk of $140; this is what will be held in reserve when the trade is opened. However, as one trade will have to settle at 100 (they can’t both be wrong), this takes your total risk down to $40, excluding exchange fees. These are the potential outcomes:
The market is below 1.1100 at expiration. This means the contract you bought will expire OTM, as the market is below 1.1100, but the contract you sold will expire ITM, as the market is also below 1.1140. You get $100 back, but put $140 into the trade, so you have a loss of $40.
The market is between 1.1100 and 1.1140 at expiration. This means that both of your contracts finish ITM, as the market is above 1.1100 and below 1.1140. You get $200 back, and put $140 into the trade, so you make a profit of $60.
The market is above 1.1140 at expiration. This means the contract you bought will expire in-the-money, as the market is above 1.1100, but the contract you sold will expire against you, as the market is above 1.1140. You get $100 back, but put $140 into the trade, so you have a loss of $40.
Of course, as with any trade, if either side of this trade starts to go against you, you may decide to close out that side early to limit the overall loss of the position.
You see, both trades cannot be wrong. By choosing this strategy, you are increasing your chances of making a profit and tipping the risk-to-reward ratio in your favor in a flat market.
Key takeaways on flat market strategies
Trading flat markets can present you with a multitude of opportunities, as long as you are using the right strategies.
Binary option contracts can help you find new and exciting ways to look to profit from flat markets. A lack of volatility doesn’t have to be dull – binary option contracts keep the pace up, allowing you to scalp, trade short-term, and use strategy variations that increase your risk-to-reward ratio.
As with any trading strategy, the main thing to keep in mind is that you need to know your markets. You would only employ the kinds of strategies described here if you expect the markets to behave in a certain way, i.e. to remain flat.
Brush up on your trading knowledge and keep up-to-date with the markets – Nadex is here to help.
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