Limiting Risk on Futures During High Volatility
Author: Gail Mercer / TradersHelpDesk.com
In January 2016, the E-mini Dow Futures fell 2,295 points following the December interest rate increase by the FOMC. In fact, January 2016 was a dismal month for most indices. History may repeat itself in early 2017, since the FOMC once again postponed its rate increase until December 2016. With the added element of a new presidential administration, the Dow may yet surge and take out the 20,000 level.
However, the issue is when volatility enters the markets, traders have very little time to enter their trades without having substantial risk at stake because markets can turn very quickly. Although market turns can be identified using hidden divergence, this type of trade can be risky for even the most experienced trader because they are counter-trend trades. Fortunately, there is a better way to trade these moves – one that allows traders to take advantage of the daily drops without risking a substantial capital – Nadex Binary Options.
Nadex Binary Options are a limited-time based trade that limits risk and provides a maximum payout of $100 per contract. When trading binary options, the trader selects a risk level that they can accept using either an Out of the Money (OTM), At the Money (ATM), or In the Money (ITM) binary. Once the trade is executed, the trader cannot lose more than they paid on entry. Plus, when trading with Nadex Binary Options, the trader may choose to close a position out early, prior to expiration to minimize losses, if the market turns against him.
For example, on January 3, 2017 the E-mini Dow Jones 15-minute chart shows that price had moved up overnight but, at the opening of the U.S. market, price initially falls (Point A) and then a bullish bar to the upside forms (Point B). This indicates the next price bar should go up but it doesn’t.
Going down in time to a 5-minute chart reveals that price was testing the previous high formed at the US opening (19,870) and failed at 19,869. Using the Stochastics Support & Resistance indicator, hidden divergence is clearly visible because price makes a lower high and the Stochastics makes a higher high (red lines on chart below).
This indicates a strong move to the downside should follow. Using binary options, a trader with a bias to the downside, could build trades as the market moves down with the advantage of limiting their risk on each entry using binary options. This way, if the market reverses, the trader could not lose more than he paid on entry.
The chart below shows illustrates 8 different Wall St 30 binary option contracts with various strikes, which is based on the E-mini Dow futures as the underlying instrument expiring, that were available for the daily expiration at 4:15 pm New York time and the red arrow highlights the completion of the 3-bar reversal pattern.
The trader could have entered any combination of the eight different strikes and either held until expiration or exited the trades early if market conditions changed, as they did in the afternoon session. Of course, traders could also choose to trade the intraday (20 minute and 2 hour) binary options, as well.
Building Trades Using Multiple Expirations
Typically, there are strikes available every two hours (depending on the instrument), plus daily and weekly strikes. On January 12th, price indicated an upward movement on both Gold and the EURUSD because the Stochastics on both charts revealed hidden divergence (higher lows in price, lower lows on the Stochastics).
The following binary trades were bought on the Nadex Demo platform just prior to the U.S. opening session in this example:
Using 2-Hour Binaries
- EUR/USD > 1.0646 by 10 am New York time - $25 risk per contract
- EUR/USD > 1.0650 by 10 am New York time - $15.48 risk per contract
- EURUSD > 1.0646 by 11 am New York time - $40.43 risk per contract
- EURUSD > 1.0650 by 11 am New York time - $34.25 risk per contract
- Gold (Feb) > 1203.6 by 11 am New York time - $30.75 risk per contract
- Gold (Feb) > 1204.6 by 11 am New York time - $22 risk per contract
Using Daily Binaries
- EURUSD > 1.0660 by 11 am New York time (daily) - $21.25 risk per contract
- Gold (Feb) > 1204.5 by 1:30 pm New York time (daily) - $34 risk per contract
Using Weekly Binaries
- Gold (Feb) > 1213.5 by 1:30 pm New York time (weekly) - $19.50 risk per contract
Based on trading one contract at each strike listed above, the total risk was $242.66. If the trader held until expiration, and the indicative price index expired in the trader’s favor, the maximum profit potential (based on trading one contract) was $657.34.
However, the trader also has the option of managing the trades and exiting at any time prior to expiration. For example, on the first two EUR/USD binary trades listed above, the trader exited the trades 8 minutes before expiration. The trader captured the following profits::
- EUR/USD > 1.0646 by 10 am New York time - $61.25 profit per contract
- EUR/USD > 1.0650 by 10 am New York time - $55.02 profit per contract
The return on investment (excluding exchange fees) on the first trade was 245% and, on the second trade, it was 355%.
On the remaining trades the results were:
- EUR/USD > 1.0646 by 11 am New York time - $31.57 profit per contract
- EUR/USD > 1.0650 by 11 am New York time - $27.75 profit per contract
- EUR/USD > 1.0660 by Daily 11 am New York time - $34.75 profit per contract
- Gold > 1203.6 by 11 am New York time - $38.75 profit per contract
- Gold > 1204.6 by 11 am New York time - $43.00 profit per contract
- Gold > 1204.5 by 1:30 pm New York time – (-$34.00) loss per contract
- Weekly Gold > 1213.5 by 1:30 pm New York time (Friday, January 14, 2017) -- (-$19.50) loss per contract
Although in this example, seven trades were profitable and two trades ended up with losses, the really great benefit of trading binary options is that even if all nine trades went against the trader (which can happen especially with counter-trend trades), the trader’s risk was always capped at $242.66 (excluding exchange fees).
Overall, the total risk and profit for the morning, based on trading one contract at each strike, was:
- Total risk on all nine trades, $242.66, and was paid when the trades were entered.
- Profit/Loss for morning, $238.59 (seven profitable trades and two losing trades)
- The overall return on investment for all trades was 98%.
To see how these trades played out on the live edge of the market in a demo account, watch the video.
Note: Exchange Fees not included in calculations.
Nadex Risk Disclaimer
Trading on Nadex involves financial risk and may not be appropriate for all investors. The information presented here is for information and educational purposes only and should not be considered an offer or solicitation to buy or sell any financial instrument on Nadex or elsewhere. Any trading decisions that you make are solely your responsibility. Past performance is not indicative of future results. Nadex instruments include forex, stock indexes, commodity futures, and economic events.
Nadex binary options and spreads can be volatile and investors risk losing their investment on any given transaction. However, the limited-risk nature of Nadex contracts ensures investors cannot lose more than the cost to enter the transaction. Nadex is subject to U.S. regulatory oversight by the CFTC.