How To Back Test Binary Option Trades
Backtesting binary options is a bit different than testing traditional trades because of the way that the timing is set up. When you enter into a binary options trade, you’re usually given an expiry time by your broker. You may have the option of exiting your trade early (whether at a win or a loss) for partial profit. You also may have the option to extend your trade with rollover. But if your broker doesn’t provide these tools, you have minimal control over how long you’re in a trade.
The only control you have is the decision to enter or not. This creates some difficulties when you’re testing trades on historical data. This is an extremely important step to becoming a professional trader.
If you’re trading for fun only, you don’t need to be so concerned with back testing. If however you actually want this to become a consistent part of your income, you absolutely must test your trading method before you go live and put your money on the line.
Anything you hope to do professionally must be treated as a business. Companies test products and services before they spend money promoting them or risk disappointing customers. As a trader, you also need to test your methods before you use them and risk losing money.
How To Back Test A Binary Option Trade
Traditionally, when you backtest trades, this is what you do. You open your charting program (think MT4 or FreeStockCharts.com) and scroll back in time to some date in the past. Depending on how long you expect your trades to last (minutes, hours, days, weeks), you might be scrolling back a couple of days, months or even several years.
When you get to the point where you’re going to start the test, you set up your chart the way you’d look at it when planning trades in real time. This means setting your support and resistance lines and whatever, if any other signals, tools or points you use to trade.
Next, you move the charts forward one candle at a time, looking at the far right-hand side of the screen. Pretend you are looking at it in real time. When you see a trade setup, you stop scrolling, plot an entry point as if you bet at this point. Now, start scrolling forward again (one bar at a time), and then you exit based on your trade rules (ie 60 seconds, 15 minutes, etc). Having trouble reading a candlestick chart? Learn how here.
Then you scroll forward again and find out whether you’ve won or lost. Mark that down, and continue onward. You should be profitable over a couple of hundred backtest trades before you even think of proceeding to real-time trading.
Why Expiry Times Pose Problems
Can you see where binary options trading makes backtesting a little awkward?
If you’re relying on your broker making trades with good expiry times available to you at the moments you’d get a signal to trade, you can’t really guess whether those opportunities would have really been available to you in the past. This can confound your results, making you think you would have been more successful than you truly would have been.
One way you can reduce this inaccuracy is to select a binary options broker right from the start who is going to give you the chance to control the timing of your trades once you’re in them. That way you aren’t quite as reliant on the broker to set good expiry times. We like a site like TradeRush or Banc De Binary as they offer early exit.
If you didn’t have rollover or early closure available to you to use, you’d have to rely on the broker to provide you with trade opportunities with ideal expiry times. You don’t want to be ejected from a trade before it goes to profit, but you also don’t want to be trapped in a trade which is going to turn against you. It wouldn’t do, for example, to enter into a trade you’d expect to stay in for several hours in backtesting with a one week expiry period. At least, that’s the case if you can’t control your exit. If you can, you can use early closure to get out before the trade is finished.
There’s another issue with using early closure, however, and that’s that it’s going to reduce your payout. Binary options sites only pay out something like 65-85% on winning trades as it is. If you exit early, you won’t even get that percentage. And if you exit all your trades early, you might average 50% or less on your payouts. Which means that you’d have to have a very high win percentage to stay profitable over time (traditional traders deal with versions of this problem too).
Suggestions for Success
- Find a broker that gives you rollover and early closure (check out TradeRush.com). This will empower you to make important trading decisions. You can’t entirely rely on these tools to be profitable over the long term, however, unless rollover produces large enough payouts often enough to make up for the profits you lose with early closure.
- Some brokers let you choose your own expiry time. This is usually referred to as the “Option Builder” feature. This is great, because it eliminates the problem with the timing altogether. (again, TR or BDB)
- Consider trading a wide variety of financial instruments. If you can find a method which works pretty well across different assets, that gives you a lot more trade opportunities. This increases the odds that you’ll find optimal setups which include optimal expiry times.
- Demo test after you backtest. This will demonstrate to you effectively whether you’re going to have difficulties involving expiry times or not. If you do, you can figure out what to do about them before you learn that lesson by losing real money. Demo testing will help you familiarize yourself with your broker’s features and decide whether they’re sufficient to help you replicate your backtesting results in real life.
If you find a broker with the right features and you do all your testing diligently, you should be able to find workarounds for the expiry time issues. The differences between binary options trading and other types of trading are no excuse not to backtest!