Dow at Record Highs: How to Trade with Limited Risk

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Dow at Record Highs: How to Trade with Limited Risk

Author: Gail Mercer/ Founder of TradersHelpDesk.com

 

Many professionals are screaming not to enter the stock market as it’s at record highs and a reversal is anticipated in the near future.  However, going against a trend can be a very dangerous thing, even when the trend is showing divergence.  Of course, divergence doesn’t always mean that the trend will change course.  It   simply identifies that the trend is weakening and needs to test for a level that will support price so that it may continue higher.  During these times when the indices are making record highs, a trader does not always have to stand aside waiting for the eventual demise of the trend.  Instead, an alternative option for trading into these overextended markets, is using Nadex binary options to limit the trader’s risk while still taking advantage of the trend continuation.

Nadex Binary Options are a limited-time based trade that limits risk and provides a settlement payout of $100 per contract if the binary finishes in the money at expiration.  When trading binary options, the trader selects a risk level that they are willing to 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, since Nadex offers multiple expirations, the trader can have   multiple trades using a combination of two-hour, daily and weekly binary options.  Here are a few examples using the Wall St 30 binaries, which is based on the E-mini Dow futures as the underlying instrument.

Trading into the E-mini Dow Jones Uptrend Using Binary Options to Limit Risk

As shown in the Daily E-mini Dow chart below, trend divergence was detected (magenta dot) because as the price was making new highs the Stochastics was making lower highs.  The result is that the price pullbacks slightly.  However, price found support at the average true range stop (plus sign) and hidden divergence forms because price makes a slightly higher low and the Stochastics indicates a lower low (yellow lines identify these areas on the chart).  Since the price has found a level of support, the price should move up again.

 

Daily E-Mini Dow Jones 

Daily E-Mini Dow Jones

 

Additionally, the 3-minute chart is confirming that the market is likely to move up, as well.  Although there have been multiple trend divergence signals (magenta dots), each one retraces back to the average true range stop and forms hidden divergence as shown with the yellow dotted lines (higher lows in price with lower lows being measured on the Stochastics indicator).  

 

3-Minute E-mini Dow Jones Chart 

3-Minute E-mini Dow Jones Chart

 

With a bias to the upside, the trader has the option of entering multiple long positions on the Wall St 30, which uses the E-mini Dow Jones as the underlying instrument, using a combination of both a two-hour and daily binary options (all expirations are based on New York time):

  • Wall St 30 > 21010 by 4:15 pm
    • Risk $25.25 per contract
    • Profit Potential $74.75, if held till expiration and the binary expires “In the Money”
  • Wall St 30 > 20981 by 10 am
    • Risk is $30.25 per contract
    • Profit Potential $69.75, if held till expiration and the binary expires “In the Money”

 

Multiple Trades Using a Combination of Binary Options 

Multiple Trades on Wall St 30 Using a Combination of Binary Options

 

The best and worst case scenarios, if held until expiration, are:

  • Price expires “Out of the Money” on both trades and the trader loses the risk they paid on entry or $30.25 per contract on the 10 am expiration and $25.25 per contract on the 4:15 pm expiration.
  • Price expires “In the Money” on the 10 am expiration and “Out of the Money” on the 4:15 pm expiration.  In this case, the trader loses the risk they paid on the daily, $25.25 per contract, but makes $69.75 per contract on the 10 am expiration.
  • Price expires “In the Money” on both the 10am and daily 4:15 pm expirations.  The profit in this case would be $69.75 per contract for the 10 am expiration and $74.75 per contract for the 4:15 pm expiration.

Additionally, Nadex also allows traders to exit their binary options early, if needed.   For example, as shown on the 10 am binary chart below, the trader has captured $ 64.75 per contract and they could choose to exit early.  In this case, even if the 4:15 pm expiration expires “Out of the Money”, the trader would still have a profit of $ 39.50 per contract ($64. 75 minus $25.25, which is the risk on the 4:15 pm strike).

 

Wall St 30 10 am Binary Option 

Wall St 30 10 am Binary Option

 

Or, if the trade moves against the trader and they may opt to exit with a $20 loss per contract for each strike, thereby reducing their loss even further.

By utilizing the Nadex binary options, traders can still participate in overextended markets with the peace of mind that, if the markets do turn against them, they have very limited risk exposure.

Nadex provides a free demo account for traders to use to learn how to utilize binary options, as well as free educational resources (including free educational webinars).

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.

 

 

 

 

 

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