The Island Top strategy is a classic signal that short sellers have used in the traditional stock market, and it is something that easily transfers over into a binary options trader’s toolbox. It is a very simple method, and doesn’t require a lot of technical prowess to identify. We’ll take a brief look at what this strategy entails, and what sort of things you should be looking out for and the drawbacks to using it.
When You Should Apply this Strategy
The island top occurs at the top of an asset’s price range. First, you should be looking for an asset that has been moving in an overall upward direction for a prolonged period of time. Traditional stock day traders should be looking for something that has moved upward for at least a couple of weeks, although this can be modified depending on the timeframes of your trades and the particular asset that you are using. After an increase in price for a while, you should then be on the lookout for a gap up. On a candlestick chart, this is signified by an area of white space in between two marks as the price drastically increased between sessions. As this is an “island,” you should then look for the asset to trade within a very tight range after the gap up.
The tight range is indicative of trader uncertainty. The price has been going up for a while, and then it just went up a lot more suddenly. Traders are not sure whether it will keep going up, so they are not buying much. But they’re also not sure if it will drop, so they are not selling much. The majority of the time, when you see this, a drop is going to occur in the near future as uncertainty breeds caution. The correct move for a binary options trader to make when they see this is to execute a put option.
Your put option should be of a longer term variety. A 15 minute option is not enough to give you a decent chance of profits. However, you can adjust your strategy depending on the timeframe of your chart. If you’ve noticed this pattern emerging in a 60 second chart, a 30 to 60 minute put option is sufficient. If you’ve noticed it on a one hour chart, your expiry should be a few days out, which usually means a week-closing expiry. As you experiment with this strategy, you will learn to tweak your expiry to be dependent upon the particular asset that you use.
Drawbacks Can Happen
The main drawback to this strategy is that meaningful gap ups usually only appear in the stock market when you are looking at a single day chart. Gaps, either up or down, do not occur often in timeframes smaller than this. This means that if you are using the island top in your stock binary option trading, you are going to have a lot of long term trades. Your trades will tend to be weeklong or even month long in nature. Most binary options traders avoid these kinds of trades as it ties their money up for long periods of time and prohibits ultra-short term gains. As such, most binary traders use this strategy as a hedge or a supplement to their typical trading routines.
In binary options, the risk of long term expiries is that something can come up that will change expectations in between the time of execution and the expiration. Unlike traditional day traders, you can’t opt to keep a trade open because there is a time limit placed upon each trade. As you consider whether or not you should use this strategy, keep this in mind.
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