Published On: Mon, Jul 17th, 2017

Digital Contracts: A new Trading Instrument

If you are a regular Forex, CFD or Binary Option trader, you are probably scratching your head at what a digital contract is?

Indeed, if this is the case then you are justified in your confusion. They are a brand new type of investment security that is giving traders the opportunity to trade on a number of different strike prices.

They are an interesting tool for those traders who have traded both CFDs and Binary Options. This is because they provide for asymmetric pay-outs with easy entry and exit.

photo/ Gerd Altmann

What is a Digital Contract?

A digital contract is essentially a combination of a Binary Option and a CFD. This is because a digital contract gives the trader the chance to either enter a CALL or a PUT on the asset at a range of different strike prices.

The trader can also enter and exit the contract easily before the expiry. This means that the trader does not have to wait until the option has expired in order to realise their profit. This is indeed a great situation for traders who like to scalp.

Some traders may then also be asking how this differs from a Binary Option with early exit privileges. The main benefit of a digital contract over a binary option is that there are a number of different strike levels around the centre.

These range from just in the money contracts to those which are far out of the money. This means that the trader can enter contracts that have pay-out ratios that range from a few percent to those that pay-out well over 1,500%.

Similarly, unlike Binary Options, the trader can make money on contracts that are already currently in the money. This could be analogous to a scalping strategy where the trader is trying to earn a relatively reduced amount for the relative certainty of the position.

Professional managed account traders have also started to use digital contracts in order to best manage risk on the clients trading portfolio. It allows the manager to take advantage of various resistance and support levels.

Digital Contract Trading Strategies

Given the nature of Digital contracts, there are a number of unique strategies that one can implement that are used to a varying degree of success with other investment instruments.

One of the most prevalent strategies at least in the Forex and CFD market is Scalping. The idea behind scalping is that the trader will enter and exit a trending asset in a relatively short period of time and hope to garner a modest return.

Scalping is sometimes termed “picking up pennies in front of a Steam roller” because the CFD trader takes a lot of risk in the chance that the market may move away from him. This is because most CFD scalpers use leverage when trading.

Similarly, scalpers rely on tight stop losses in order to limit these losses should the asset move against them. However, in really volatile markets, there is the chance that the stops wont execute and the trader is loses a large degree of their capital.

With a digital contract however, the loss is only limited to the initial investment in the option. Hence, the scalper will know with certainty how much they are likely to lose if the asset goes in the opposite direction.

Similarly, because digital contracts can be exited early and initial profits taken, digital contract scalping is a true reality.

Another way digital contracts can be used is when trading on price action events. These are events that happen as a result of fundamental factors in the market like Economic data releases and announcements.

Price action events also sometimes lead to large jumps in the price of an asset should there be a situation in when the actual numbers that are released are greatly different from the market expectations.

In this case, the deep out of the money digital contracts could be entered on the hope that the market has miss-read the announcement greatly. This means that the trader will most likely be able to exit the Digital contract trade in the money.

As this digital contract was entered into when it was deep out of the money, the payoff could be as high as 1,500%. This means that the trader could get a relatively large payoff from their investment. Similarly, the amount at risk is fully known at the outset so there is only a certain degree of risk.

Author: Janet Preston

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