Using a Multi-Time Frame Confirmation to Trade Binary Options
Author: James Ramelli / AlphaShark Trading
The Ichimoku Cloud is one of the most powerful and versatile technical indicators around. It is designed to help a trader analyze a markets underlying trend at a single glance. What makes the cloud such a powerful indicator is the simplicity of its application to almost any market. A trader can use the cloud to get a solid understanding of the strength and direction of trend in any chartable product. The key to the applying the cloud correctly is understanding the correct time frame to use for the specific security you are analyzing. In this article we will discuss a simple but powerful concept known as multi-time frame confirmation with the Ichimoku Cloud. It allows a trader to make smarter decisions about trade entries and also helps a trader avoid less favorable trades. The examples we will focus on here will revolve around setups in currency markets and their application to binary options trading.
To understand this strategy we first need a basic understanding of the Ichimoku Cloud. Below is a 15 min chart of the AUD/USD currency pair with the Ichimoku Cloud applied.
Here we can see a clearly defined shaded area. This part of the Ichimoku Cloud is known as the “Kumo.” This is essentially a line in the sand showing us areas of bullish and bearish territory. Anytime the market is above the Kumo it is in bullish territory and anytime the market is below the Kumo it is in bearish territory. The simplest way to trade the cloud is to trade breaks of the Kumo. If the market moves below the Kumo a trader would get short and would look to get long if the market moves above it. This can be a very successful strategy if a trader is using the appropriate time frame to chart and trade these breaks.
The 15 minute bar is a very fast time frame for a currency pair. The general trend tends to develop on higher time frames. The issue with this is that a trader who wants to be more active will not be given many opportunities for entries if they are taking them off of the 4 hour, daily, or weekly bar. To trade a time frame like the 15 minute with confidence a trader needs a method of confirming the signals and avoiding traps. Let’s look again at the 15 minute chart in the AUD/USD.
We can see above that the upside break of the cloud let to a very nice intraday trade setup. How could a trader have had the confidence to take this long signal on such a fast chart? The answer lies in the strategy of multiple time frame confirmation.
Essentially a trader is looking to analyze the strength of trend according to the Ichimoku Cloud on higher time frames. This will show a trader the direction and strength of the broader trends and can confirm their entries on faster time frames. For currency pairs we want to confirm the trend on the 4 hour bar, daily bar, and weekly bar. If the trends agree with each other on these higher time frames we can then focus on directional breakouts on lower time frames. Let’s examine those charts below.
In the above charts we can clearly see that all of the higher time frames show the market in bullish territory. This tells two very important things about trade setups in the AUD/USD pair.
- All short setups on the 15 minute bar are invalid and should be ignored
- A trader can take long breakout setups on the 15 minute bar as they are confirmed on the higher time frames.
With this in mind a trader could take the entry flagged by the upside break of the Kumo. A trader would look to enter a long position at the close of the candle. A trader who wants to approach this setup with binary options can do so knowing that their risk is limited and the setup is confirmed by higher time frames. Let’s look at some examples below.
Long signal fires at the close of the candle at 0.76818
A trader could choose to approach this setup with a number of different binary options. In this case we will look at setups using the Daily 3pm Expiry options.
Possible at the money setup: Buying the AUD/USD > 0.7680 Daily 3pm Binary option for $55
Risk: $55 per 1 lot
Reward: $45 per 1 lot
In this case a trader is getting a great risk to reward ratio and doesn’t need the market to move any higher. As longs as the market does not sell off into the expiration of the option it will settle at full value and provide a trader with an ROI of nearly 82 percent. This would be impossible to replicate in the underlying. As you can see in the chart, this trade would have done very well.
Possible Out of the Money Trade: Buying the AUD/USD > 0.7700 Daily 3pm Binary Option for $30
Risk: $30 per 1 lot
Reward: $70 per 1 lot
This trade gives a trader a better than 2-1 reward to risk ratio and does not require an outsized move before expiry to get a trader to maximum profit. Since the setup is confirmed on higher time frames a trader can take this trade knowing that there could be strong momentum after the break and that they can get a great return on their money.
There is any number of ways to trade these setups. The important thing is for traders to only focus on the pairs that have confirmation across all of the higher time frames. This may seem like a very selective way to find signals but with 10 pairs listing binary options on Nadex a trader will never be at a lack for signals. This method can help a trader find setups that are more suitable for intraday trading while avoiding the traps that are normally associated with trading currencies on such a fast time frame.
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.