Using Fib Retracements in a Binary Way

Using Fib Retracements in a Binary Way

Last week, the EUR/USD currency pair market found a bottom early in the week and then trended higher into the week’s close, followed by some double-top type price action this week. The Forex pair is now trading lower, shown on the thirty-minute bar chart below.

Using Fib Retracements in a Binary Way
Using Fib Retracements in a Binary Way Getty Images

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.

Using Fib Retracements in a Binary Way

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, Using Fib Retracements in a Binary Wayas 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.

The information contained above may have been prepared by independent third parties contracted by Nadex. In addition to the disclaimer below, the material on this page is for informational and educational purposes only and should not be considered an offer or solicitation to buy or sell any financial instrument on Nadex or elsewhere. Please note, exchange fees may not be included in all examples provided. View the current Nadex fee schedule. Nadex accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representations or warranties are given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk and any trading decisions that you make are solely your responsibility Trading on Nadex involves financial risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results. Nadex instruments include forex, stock indexes, commodity futures, and economic events.

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