When trading Forex or any market, many traders use Fibonacci retracements, a technical tool that helps identify potential market reversals. The chart below identifies the Fibonacci levels from last week’s low to high, with the 50% marker painted brighter for effect.
The 50% marker can oftentimes be a pivotal area. In a market like EUR/USD, which was trending higher last week, a 50% retracement could be an indicator to buy a pullback in a short term, up-trending market.
The EUR/USD is currently trading at 1.0500 area, and the 50% Fib retracement is at 1.0481. This currency pair is weak today, but by the time it gets another 20 pips lower to the 1.0481 price level, selling may have exhausted itself, and it is possible that the market could reverse course.
We will use this instance as an example of how to trade Forex using binary options on a Fibonacci reversal signal. These options have a $100 base value per contract and are regulated by the CFTC. Please note that this example is not a recommendation of a specific trade, but is intended to be used as an educational tool of one possible way traders may use Fibonacci levels with binary options.
Among the many binary options currently being offered is a daily 1.0480 strike (the same price level as the Fibonacci 50% retracement), which expires tonight at 11:00 pm EST. Currently, this option’s offer is at $81.25, as shown in the image of the order ticket. This binary strike is priced higher as the underlying price is well above strike giving the binary buyer the immediate trade advantage.
If you thought the EUR/USD may retrace down to the 50% level but finish above the strike at expiration you could pay the $81.25 per contract. However this may be more than a trader is willing to risk per contract at the moment and remember if the EUR/USD price goes lower during the day, so will the value of this binary option prior to expiration.
If the trader is willing to wait for the potential break and the EUR/USD actually does retrace back to the 1.0480 level, then this binary option would likely be offered around $55.00. Assuming the trader anticipates the market to bounce off the Fibonacci 50% level and trade higher, the trader then could buy this binary and risk $55 to make a profit of $45 per contract assuming the binary finishes in the money above the strike. However if the market never quite retraces back to the 50% Fibonacci level then the trader misses the trade opportunity and has no trade.
On the other hand, let’s say you decided instead to sell this option. If you anticipate the underlying trading lower and potentially reached the 1.0480 price level, you could sell the binary at 73 now where your risk is $27 (100-73) per contract. If the underlying did trade down to this level you could buy it back around $55 per contract if you were anticipating a bounce or leave the position open if you thought there was going to be more selling pressure.
This example applies to binary options as a whole. If the instrument, such as the EUR/USD pair, settles above an option strike, buyers would earn maximum profit; if the instrument settles at or below that strike, sellers would earn maximum profit.
In addition, with binary options, traders may close their position with these options prior to expiration in order to take an early profit or stop loss.
In this example, traders do not need to sit and wait all day watching the charts to see if price reaches their desired level. By knowing which strike they want and at what price, if they wish, traders may set a limit order and then come back at expiration to see if the trade worked. With the defined risk in binary options, you can place an order for your trade and walk away if that suits you.
Note: Exchange fees not included in calculations.