Estimated reading time: 5 minutes
Due to the very nature of markets, regardless of the strength of a given trend in an asset-price, retracements are always parts of the equation. Retracements happen for a very logical reason: no matter how quickly an asset-price gains momentum, there will always be trading entities out there (institutional players or individual traders), who will decide to take their profits. Even though strong trends survive such profit taking and continue unabated on their previous path, the retracement will be there, representing a great opportunity for options traders who know how to take advantage of them. The Fibonacci retracement tool, which is regarded as one of the least understood indicators in trading, is one of the best tools one could ask for when it comes to trading the Touch component of the Touch/No Touch contract as well as the Put/Call contract. How exactly do we put it to use? Let’s start with the beginning.
For the system built upon the use of the Fibonacci Retracement tool, we’ll use daily charts for the analysis. This is extremely important, not only because of the way it impacts the actual expiry times on the trades (as you’ll see below), but also because smaller time-frames (like hourly charts) simply will not work for the sort of analysis we have to do. Such time frames come loaded with what they call intra-day noise, which has little to do with actual trends and trend-retracements and which can indeed be extremely confusing. Something that may look like a retracement on one of these charts will simply turn out to be part of a completely different trend on the daily chart. To make a long story short: we need the daily chart to make sure we do indeed spot the profit-taking-induced retracements we’re looking for.
Let’s see what the actual strategy is about though. What we’ll do is we’ll use the Fibonacci retracement tool to set a number of possible price targets as the retracement gets underway (essentially targets the price-action is likely to reach). While the system can be used for the trading of the Put/Call options, it is not suitable for the trading of the No Touch option (only the Touch component can be traded as said above). For the Touch trade, one of the price-targets pointed out by the Fibonacci tool will be the actual strike-price.
How do we use the Fibonacci retracement tool though and how does it work? The tool sets 5 potential retracement points, which correspond to the following retracement levels: 23.6%, 38.2%, 50%, 61.8% and 100%. These levels will determine our potential strike-prices on the chart.
There are two potential scenarios in which we can call upon this strategy. The first one is when we have an uptrend experiencing a downward retracement. The second one is a downtrend seeing an upward retracement.
In the first case, we take the Fibonacci retracement tool and we link the lowest price-point on the chart with the highest one (the swing low to the swing-high). In the second case, we link the swing high to the swing low. The tool will then automatically draw up the 5 Fibonacci retracement levels which we’ll be able to use for the strategy. In case we use a Fibonacci tool off a website, we will simply have to feed the swing high and swing low values into it manually, after which it’ll give us the retracement level values, which we’ll be able to draw onto the chart.
For the Call and Put trades, we’ll need to find the end of the retracement, which will occur at one of the Fibonacci levels. Since there are 5 such levels though, we’ll need to bring in the stochastic oscillator to be able to identify the actual strike-price for the trade. If we are dealing with an upward main trend, we’ll look for the lines of the stochastic oscillator to cross on an oversold level (<30) on one of the Fibonacci levels. When this point is found, the trader should purchase a Call option (since the price will head back upward, as the original trend resumes.
If we’re dealing with a downward main trend and an upward retracement, we will once again make use of the stochastic oscillator. In this instance though, we’ll look for its lines to cross at an overbought level (>70) on one of the Fibonacci retracement levels. If we find this point, this is where the Put trade is warranted. Both the Call and the Put trade has to be placed as soon as possible after the above said conditions are fulfilled (preferably on the very next candlestick).
Given that we have used the daily chart for analysis as said above, the expiry on these trades should be set to at least 7 days.
The Touch trade can be traded in two different ways with this system. The first method is the “straightforward” one, the one aiming to take advantage of the actual retracement, rather than the subsequent return of the dominant trend. The theory behind it is that once the retracement begins, it is likely to break through the 23.6% and 38.2% levels. With that in mind, the trader will wait for the asset-price to cross the 23.6% level and if the retracement continues, the Touch trade is placed, using the 38.2% level as the strike-price. The expiry on this one should be set to at least 10 days.
The second method is a little more tricky, as it’s aiming to take advantage of the return of the original trend after the retracement blows off its steam. Because we need to find the end of the retracement, we will once again use the stochastic oscillator. We will once again use it in the manner described above. Once the end of the retracement has been located, we’ll use the previous Fibonacci retracement level as the strike-price for the trade.
All this makes perfect sense of course, but before you actually take the system into a real money trading situation, you should put it to the test through a risk-free demo account and see if you really do master it.
Philip Thalberg has been trading binary options since the first online brokers started popping up. He is currently a full-time professional trader and an enthusiastic user of automated binary trading software, which is what his personal site is about too.