Last week, the Austrailian Bureau of Labor Statistics released its December CPI data. The inflation number came in at .8 instead of .4, causing a lot of volatility on the AUD/USD forex pair. Speculators tried to grab some of the move that was expected right after the announcement. Others sat back and let the news come out and be over with, before they got back into the markets.
The issue is, you and the speculators honestly had no idea which way the market was going to move when the Australian CPI number was announced. But what you did have the ability to know is how far the AUD/USD moves on average when this statement comes out. Using the weekly economic outlook calendar, you would have known that the projected move on AUD/USD when the Bureau of Labor Statistics released the CPI number is 50 pips. (See Economic Outlook HERE)
With a straddle, you don't have to sit aside and watch the move and you don't have to pick direction; you just need to have an expected movement at a specified time in either direction.
So instead of trying to be a guru and pick direction, or sitting aside and missing out on the move, you could also do a simple straddle using Nadex spreads. So long as the market moves far enough in either direction, you could have profited on the trade doing a Nadex Straddle.
What is Forex: Forex, also known as FX and Foreign Exchange, is buying one currency in exchange for another. For example, if you travel from the U.S. to Australia, you might go to the foreign exchange booth at the airport and provide them U.S. dollars. They will then provide you the equivalent value at that time in Australian dollars.
The value you get fluctuates, and you can trade these nearly every single day of the week. And you don't have the large $25,000 account size requirement to do shorter-term day trades like you do in stocks.
What is a Pip: A pip is a minimum increment move; i.e., on stock, a "cent" is a minimum increment move. So one could say a pip on a stock is .01. It is simply the last digit the trading instrument is quoted in. The term pip is used on forex, and as you are dealing with multiple currency pairs it's easier to say "pip" than "cent aussie," "Australian cent," etc.
On a stock, .01 is worth 1 cent. So when a stock moves .01, the value goes up or down by 1 cent. On Nadex spreads, a pip is worth $1.00 no matter what instrument it is. So when the forex pair moves by .0001 then the value goes up or down by $1.00. This is a benefit in the North American Derivatives Exchange, or Nadex, as you don't have to deal with currency conversion at all when trading Forex).
Who is Nadex?
The North American Derivatives Exchange is based out of Chicago and is regulated by the U.S. Futures Trading Commission (CFTC). Nadex allows traders to trade binaries and spreads on foreign exchange (forex) markets, U.S. and International Stock Indices, and Commodities like gold and oil.
Leverage and Low Risk: Trading forex allows you to trade with large leverage, depending on the broker, of up to 50:1. So you have $50 of buying power leverage of $50 for every $1.00 put up to trade. Unfortunately, leverage can cut both ways -- with Nadex the leverage can not only be 50:1, but even much higher, and the leverage works for you but not against you. The reason is with Nadex, all risk is capped and your risk never increases from the initial risk, no matter how far the market moves against you.
What Is a Spread and a Straddle on Nadex?
Let's say that, at 6:00 pm ET, the AUD/USD was trading right around .8801. You could have then entered an 8:00 pm or 9:00 pm expiring straddle trade.
The chart below shows how a spread would look. The upper box shows how far up the market it can move and when you profit. If the market expires at or above the top of the box, you will receive maximum profit. You can't lose any additional under the lower part of the blue box on the long spread.
The pink box shows the short spread, and you can profit down to the lower part of the box. You will get max profit if the market expires at or below the box. You cannot lose any additional amount above the top of the pink box on the short spread and can't be stopped out.
Your max loss and max profit is determined. You can enter and exit before expiration (i.e., you can take set profits). The profit on your trade is simply the net difference between where you buy and sell (or sell and buy, if shorting).
This is not like a binary, which can be all or nothing. It is a variable payout product known as a Nadex spread and is also offered by Nadex.
If you both buy the upper spread and sell the lower spread with the same expiration, this is called a straddle.
So, how do you do a straddle on Nadex?
1) Buy The Upper Spread
- You could have bought the upper .8810 to .8910 9:00 pm ET spread at around 6:00 pm ET for a price of .8818.
Risk is calculated on a bought spread as the difference between where you buy and the floor (lower strike of the spread). The floor is .8810, though the bought price is .8818 -- making the risk .0008, or 8 pips. Every pip is worth $1.00, so your risk is $8.
Reward is calculated on a bought spread as the difference between the ceiling (higher strike of the spread) and the price you buy the spread. The ceiling on this spread is .8910 and you bought at .8818. This makes the max reward potential .0180 or 180 pips. With every pip worth a dollar, that is a profit potential of $92.
- 2) Sell The Lower Spread
You could have sold the lower .8710- .8810 9:00 pm ET spread at around 6:00 pm ET, for a price of .8789
Risk is calculated on a sold spread as the difference between the ceiling (upper strike of the spread) and where you sell the spread.
- The ceiling was .8810, and you sold at .8789. This makes the risk .0021, or 21 pips. Every pip is worth $1.00, so your risk is $21.
- Reward is calculated on a sold spread as the difference between where you sold the spread and the floor (lower of the spread). The floor on this spread is .8710 and you sold at .8789. This makes the max reward potential .0190, or 190 pips. With every pip worth a dollar, that is a profit potential of $190.
3) Calculate the Max Risk
Combined, the max risk on the trade is $29 ($8 on the long and $21 on the short side). And there is plenty of profit potential for a 1-to-1 or higher profit on the trade.
4) Calculate a 1-to-1 Profit Ratio
For a 1-to-1 take profit you would simply take the total risk, plus the risk on either side, to know where to take profit for 1 to 1. For example, total risk is $29 + 21 risk on the short side. You need to make $50 on the bought side for a 1-to=1, as you are counting on the short side loosing the $8, netting you a $29 profit.
Or, in reverse, total risk is $29 + $8 risk on the long side. You need to make $37 on the sold side for a 1-to-1 as you are counting on the long side loosing the $21, netting you a $29 profit.
Now you need to add 50 pips to the price at which you bought the upper spread, and set that as your take profit to sell it to exit. Bought the .8810 to .8910 9:00 pm at .8818 -- once filled, a take profit to sell it back at .8868.
Likewise, you need to subtract 50 pips for the price on the one you sold, and set an order to take profit, to buy it back at as your take profit to exit. Sold the .8710- .8810 9:00 pm ET at .8789 -- once filled, set a take profit to buy it back at .8752
(Note: we are just talking 1 straddle at $30 - you could do 1, 10, 100 etc... to multiply out the value)
5)Before entering your take-profit order, make sure you have an expectency on move like Diagnostic Deviations that are implied volatility. This gave you a hint to be ready to close this trade, as the market had reached its maximum expansion point when it hit the 1 deviation level. With a take profit of .8868 we hit a high of .8869, so it did make it. However, with a +1 diagnostic implied deviation level of .8866, it would have been wise to tighten up the take profit before this level and give up a few ticks and take profit a bit earlier, as the market often does not exceed a deviation level.
So how did the trade work out?
As seen below, the trade was entered and the market took off and you easily surpassed the 1.1020 take profit goal giving you your 1-to-1 take profit. And you had the ability, if so desired, to trail your stops for a reward potential of greater than 1-to-1. If you held to expiration, the market expired at 1.0820 so the profit would have been approximately $102 on the long spread with a $10 loss on the sold spread. This netted a little over a $90 profit on a $30 risk for a 300% return investment, with a max risk of only $30 and no ability to be stopped out of the trade.
The Upper Spread flew up and did hit the .8868 original goal with the market and hit take profit goal netting you at or close to a 1-to-1 (100% return on risk)
The lower spread capped out on its loss, enabling the long spread to continue profiting on the up move and surpassing the loss on the short spread.
To see examples of trading the news on Nadex binaries and spreads, see these articles posted on Benzinga, click here.
On Nadex the markets are open from as early as 6:00 pm ET to as late as 5:00 pm the next day, giving the ability to trade day and/or night on intraday, daily and weekly contracts.
If you would like to learn more about trading Nadex binaries, check out this 16 video course, absolutely for free, on Marketfy.
(c) 2014 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.
This article was written by Darrell Martin from Benzinga and was legally licensed through the NewsCred publisher network.