These strategies are primarily based on the concepts of correlation. However, what is this parameter and how can you use it to trade binary options more successfully? To begin with, you need to appreciate that the directional movements of many assets are highly correlated. If you can learn how to proficiently recognize these trends, then you will definitely improve your ability to trade binary options successfully. In addition, correlation coefficient strategies can provide you with opportunities to profit irrespective of which way the market is currently advancing, i.e. sideways, downwards, or upwards.
Specifically, correlation monitors and quantifies the degree by which the price of the first asset advances in relation to that of another. The measure of correlation is assessed by utilizing a scale extending from +1 to -1. A full positive correlation is identified by a reading of +1, which implies that two assets are progressing in total harmony by advancing in identical directions, i.e. if the price of one is rising then so will the other. In contrast, a perfect negative correlation is recorded by a value of -1 and indicates that two securities are progressing in totally opposite directions.
As correlation declines towards its zero level, such movements infer that the directional price movements of the two assets under study are becoming less oriented. Experts in this subject advise that correlation readings are only truly significant whenever they record figures above 0.7 or below -0.7. Numbers that fall outside these ranges are deemed to be less relevant because they are not sufficiently strong enough on which to base quality trading decisions.
Correlations are also often expressed in terms of percentages. When such a convention is adopted this parameter is then known as the coefficient of determination. When you are trading binary options, you can incorporate the concepts of correlation into any strategy that you are using and can apply its principles to any pair of interrelated assets supported by your broker. Although you can definitely base a strategy on correlation as its primary indicator, you will also find that many traders prefer to use it as a secondary verification tool.
(Risk warning: Your capital can be at risk)
Example of a correlation coefficient strategy
You will find that competing companies that trade in the same market sector possess a high correlation, e.g. Google/Apple, Vodafone/BT, and Exxon/Shell, etc. You can acquire deeper insights into this subject by studying the following example. Envisage that you are monitoring the trading charts of Amazon and Google as both firms are very active in the current mobile device market.
News is then released disclosing that Amazon has just upgraded one of its flagship products causing the price of its shares to surge higher. As this development should adversely influence Google, you study its performance but do not detect any downward movement as of yet. As you consider that it is only a matter of time before Google’s shares plunge, you activate a PUT binary option based on this company in order to exploit the correlated relationship existing between it and Amazon.
Correlation coefficient strategies are also considered to be a form of market-neutral strategy because they enable traders to attempt to profit from the deviations in the relative price movement of one asset relative to that of another. They also provide the important benefit of not being dependent on the current and future directional price movements of securities. This means that you can then benefit from trading binary options no matter in which direction the price is moving.
Essentially, you will be aiming to exploit any new divergences indicating that the trading performance of your two selected assets is beginning to diverge. You must open a CALL binary option if you opt to support the asset that you consider to outperform its counterpart before expiration. Alternatively, implement a PUT binary option if you want to back the under-performing one.
Introducing pair options
A completely new brand of binary options has recently been introduced into the market, called pair options, that has been specifically designed to exploit the benefits of correlation. In particular, pair options enable you to speculate on the relative performance of two highly correlated assets by activating just one trade and not two. Another important feature of pair options is that they are ideal vehicles upon which to construct strategies that have the prime intent of utilizing the benefits of correlation.
You will discover that correlation is a very useful parameter to monitor and track because it can generate values that can be used to forecast the price relationships between assets that are very effective in real trading situations. For example, if you detect that the correlated relationship between Coke and Pepsi is beginning to suddenly diverge, then this would be a great time to execute a pair option based on Coke/Pepsi. If you favor that Coke will outperform Pepsi then you should open a CALL binary option. Alternatively, implement a PUT binary option if you support Pepsi.
Probably the main benefit of correlation is its ability to identify new trading opportunities by detecting when the trading performances of two closely matched assets are starting to deviate. If you decide to utilize a correlation coefficient strategy then you should consider incorporating another major technical indicator as a verification source. Many traders use the Bollinger Bands for this purpose.