Trading technical indicators with binary options can be a highly profitable trading style – if you know how to do it right. Our article explains the basics and three examples of strategies that you can use. In detail, you will learn:
- What Are Technical Indicators?
- Why Are Technical Indicators And Digital Options A Great Combination?
- Three Examples Of Strategies For Technical Indicators
With this information, you will immediately be able to trade binary options with technical indicators.
What Are Indicators?
Technical indicators are helpful trading tools that allow price action traders to understand what is going on in the market and make predictions about what will happen next.
Some indicators draw their results directly into the price chart, which makes it easy for analysts to compare them to the current market price. Other indicators use a separate window to display their results. The most well-known example of this type of indicator is oscillators. These indicators create a value that oscillates between 0 and 100. This value and its change over time allow you to understand what happened in the past and what will happen next.
There are thousands of indicators, but these are the most important types and a few examples:
- Support & resistance: These indicators predict support and resistance levels at which the market is likely to turn around. When it breaks through such a level, it will likely create a strong movement away from the price level. Examples: Bottom, Fibonacci retracement, Pivot point (PP), Top.
- Trend: These indicators help you evaluate the strength and trustworthiness of trends. Examples: Average directional index (A.D.X.), Commodity channel index (CCI), Detrended price oscillator (DPO), Know sure thing oscillator (KST), Ichimoku Kinkō Hyō, Moving average convergence/divergence (MACD), Mass index Moving average (MA), Parabolic SAR (SAR), Smart money index (SMI), Trix Vortex Indicator (VI).
- Momentum: These indicators help you understand the momentum of a movement. Examples: Money flow index (MFI), Relative strength index (RSI), Stochastic oscillator, True strength index (TSI), Ultimate oscillator Williams %R (%R).
- Volume: These indicators use the trading volume (the number of assets sold or bought) to evaluate whether investors are more bullish or bearish. Examples: Accumulation/distribution line, Ease of movement (EMV), Force Index (FI), Negative volume index (NVI), On-balance volume (OBV), Put/call ratio (PCR), Volume–price trend (VPT).
- Volatility Indicators: These indicators measure the strength of a movement, which helps traders to make a variety of predictions, especially for binary options types that use target prices, for example one touch options, boundary options, or ladder options. Examples: Average true range (ATR), Bollinger Bands (BB), Donchian channel, Keltner channel, CBOE, Market Volatility Index (VIX), Standard deviation (σ).
There is no need to learn all of these indicators. Take a look at each category, choose the one that you like best, and take it from there. It is best to start with an indicator that you truly understand and like. Later you can add more indicators to your strategy, allowing your trading to evolve naturally.
Why Do Indicators Suit Binary Options?
Most binary options traders rely heavily on technical indicators. There are mainly three reasons for this strong connection between binary options and technical indicators:
- Technical indicators simplify price action analysis. Price action is the only way to predict what will happen on such short time frames as you use within binary options. Just looking at price movements can be confusing, though. Technical indicators can filter the most important information of a price chart and display it in a way that everyone can immediately understand. This simplification makes your trading quicker and easier.
- Indicators secure your trading. When you analyze the market without any help, there is a lot of information to take in. Complexity leads to mistakes and bad decisions, both of which cost you money. Technical indicators eliminate these mistakes, which is why they help you make more money in a simpler way – a great combination.
- Indicators can reveal things no trader can. Within a split second, technical indicators analyze hundreds of datasets, filter out the most relevant information, and display it in a way that everyone can understand. Without the help of technical indicators, most of this information would be inaccessible. It would take years to calculate the Bollinger bands for fifty assets with ten time periods each. Technical analysis adds layers of information to your trading that would have been hidden otherwise.
These points are the reasons why technical indicators and binary options are such a great combination.
What Are Leading Indicators?
Leading indicators are a special form of market indicators. Market indicators are everything that helps you understand whether the price of an asset will rise or fall in the future. They provide an important, helpful, and easy-to-interpret tool of for binary options traders. With the right strategy, they can help you anticipate new market movements and find the ideal timing to invest.
These indicators can be categorised into two types:
- Leading indicators. This type of indicator predicts what will happen to the price of an asset.
- Lagging indicators. This type of indicator tells you what has happened to the price of an asset. While this information is supposed to help you predict what will happen next, the indication itself focuses on the past – this is the big difference between both types of indicators.
The goal of leading indicators is to give you a sense of where the price of an asset is heading. A great example of a leading indicator from another field is the business climate index. Business managers report their expectations for the future, and the index creates an aggregated value that easily can be compared easily to previous months and years. The value and its change over time help you to predict whether the economy will improve or get worse.
Leading financial indicators do the same thing. They measure something, and the resulting value tells you whether things will get better or worse.
Why Should I Use Leading Indicators?
Leading indicators serve a very important purpose: they can help you understand whether an existing movement is more likely to continue or to end soon. With this indication, you can find great trading opportunities and avoid bad ones.
For example, assume that you find an upwards movement.
- If your leading indicator tells you that the movement likely will continue, you know that this is the right time to trade a high option.
- If your leading indicator tells you that the movement likely will end soon, you know that now is not the right time to trade a high option. You should either stay out of the market or trade an option that predicts the impending end of the movement.
For any trend follower, swing trader, and almost anyone else, leading indicators add important information to their trading style. They can help filter out bad signals, find new trading opportunities, and win more trades.
Popular Examples Of Leading Indicators
There are hundreds of leading indicators. Some of them are similar, some very different. To help you understand leading indicators better, we will now take a look at three different examples of leading indicators that allow you to get a good feel for the different types of leading indicators.
Example 1: The Money Flow Index (MFI)
The Money Flow Index (MFI) is such a popular leading indicator because it helps traders quickly evaluate the strength of a trend.
As the name indicates, the MFI compares the money that flows into an asset to the money that flows out of it. For this purpose, it multiplies the average of each period’s high, low, and closing prices with the period’s volume and then divides the sum of all periods with rising prices by the sum of all periods with falling prices.
The result is a value between 0 and 100.
- When the MFI reads 100, all the money was flowing into an asset – all periods featured rising periods.
- When the MFI reads 0, all the money was flowing out of an asset – all periods featured falling prices.
- When the MFI reads 50, the number of sold and bought assets was exactly equal.
Every value over 50 indicates that more people sold than bought the asset, every value under 50 indicates the opposite.
The MFI’s reading and its change over time allow for two predictions about future market movements:
- Extreme values. When the MFI is too high (usually over 70) or too low (usually under 30), the market enters the extreme areas. Traders assume that such extreme values indicate that too many traders have already bought or sold an asset and that there are no more traders left that can buy or sell the asset and keep the movement going. Consequently, they predict that the movement is in trouble and soon will either turn around or go through a consolidation before it can continue. Some traders use this signal to stop investing in the movement; some already invest in the opposite direction.
- Convergence/divergence. When the market forms a new extreme in a trend (a new high in an uptrend or a new low in a downtrend), the MFI should mirror this movement and create a new extreme, too. When the MFI does not mirror the market’s new high/low with its own high/low, traders have stopped pushing the trend. While this was still enough to create a new extreme, a continuing decline in momentum would end the trade. Some traders would use this signal to stop investing in a trend, some to invest in the opposite direction.
Of course, you can also interpret the MFI in the opposite way:
- When the MFI reads between 30 and 70, there is enough room for the market to continue its current movement. Most traders would predict that the movement will continue for a while and invest accordingly.
- When the MFI mirrors the current trend, the trend is intact. Most traders would predict that the trend will continue and invest accordingly.
The MFI is a leading indicator because it predicts that a trend or movement will continue or end soon. Lagging indicators would only tell you what happened to a movement in the past.
Because the MFI’s value oscillates between 0 and 100, it is called an oscillator. Most other oscillators are leading indicators, too. If you like the idea of having a simple on which to base your investment decisions, take a look at other oscillators technical analysis has to offer.
Example 2: The Commodity Channel Index (CCI)
Don’t let the name fool you – the Commodity Channel Index (CCI) works with all types of assets, not only commodities.
Simply put, the CCI calculates how far an asset has diverged from its statistical mean. The theory is that when an asset has strayed too far from its mean price, it will soon have to come back. Just like with MFI, the CCI assumes that when too many traders have bought or sold an asset, there is nobody left to push the market further in this direction. It has to turn around and consolidate.
In detail, the CCI multiplies the last complete period’s average of high, low, and closing price with 0.015 and puts the result in relation to a smoothed moving average.
- Values over 100 indicate that the asset is trading higher than 1.015 times of the moving average’s value.
- Values under -100 indicate that the asset is trading lower than 0.985 times of the moving average’s value.
In both cases, the CCI predicts that the market has moved too far from the moving average and that the movement will soon turn around.
Some traders also wait before they invest.
- When the CCI has risen over 100, they wait until it starts to fall before they invest.
- When the CCI has fallen below -100, they wait until it starts to rise before they invest.
These traders use the CCI more as a lagging indicator. To use the CCI as a leading indicator, you have to invest when the market crosses the +100/-100 lines – then you invest in anticipation. When you trade the changing direction, you invest in reaction and use the CCI as a lagging indicator.
Sometimes the line between lagging and leading indicators can be thin. As long as you know the difference and trade accordingly, you should be fine.
Example 3: The Relative Strength Index (RSI)
On first glance, the Relative Strength Index (RSI) appears to be pretty similar to the Money Flow Index (MFI). Both are oscillators, create a value between 0 and 100, and use an overbought and an oversold area.
The difference between both indicators is that the RSI focuses solely on price change while the MFI also considers the volume of each period. While the RSI treats every period equally, the MFI puts more weight on periods with a high volume and less weight on periods with a low volume.
Other than that, you can use the RSI just like the MFI. Trade divergences and the oversold areas above 70 or below 30. When the RSI is between 30 and 70 the current movement should still have some room; when it mirrors a trend, the trend is fine.
Neither the MFI nor the RSI is always better. Which indicator you should use depends on your strategy, your personality, and your beliefs about the market.
- Some traders argue that they trade the price, not the volume and that they, therefore, should ignore volume. They also say that the volume is too similar on the short time frames of binary options to have an effect. These traders should use the RSI.
- Some traders argue that the volume does have a significant effect because it tells you which direction more traders support. These traders should use the MFI.
How To Trade Leading Indicators With Binaries
All leading indicators can be the sole basis of your trading strategy or an additional feature to your current strategy to filter out signals. We will present strategies that use leading indicators in both ways.
Strategy 1: Trading The MFI Divergences With High/Low Options
We already pointed out that the MFI mirrors an intact trend.
- When an intact uptrend creates a new high, the MFI creates a new high, too.
- When an intact downtrend creates a new low, the MFI create a new low, too.
When the MFI fails to mirror a trend’s new extreme, the trend is in trouble. The trend is losing momentum, and while it still had enough power to create new extreme, it seems that this was the trend’s last extreme.
High/low options offer you the perfect tool to trade this prediction.
- When the MFI diverges in an uptrend, invest in a low option.
- When the MFI diverges in a downtrend, invest in a high option.
The important part of this strategy is getting the expiry right. While it is highly likely that the market will follow an MFI divergence by changing direction or entering a sideways movement, these movements take time to develop. It is important that you choose your expiry long enough to provide the market with this time.
When you find an MFI divergence in a 5-minute chart, for example, an expiry of 15 minutes would be insufficient. The market will take at least 10 periods to turn around, and a 15-minute expiry would only be the equivalent of 3 bars. Choose an expiry of one hour, and you increase your chances of winning the trade.
You can also trade this strategy with the RSI. You would just switch indicators, without changing anything else.
Additionally, you can replace high/low options with low-risk ladder options. Ladder options work just like high/low options but allow you to use a price other than the current market price as the reference point for your prediction.
- After an MFI divergence in an uptrend, you predict that the market will trade lower than a price that is above the current market price.
- After an MFI divergence in a downtrend, you predict that the market will trade higher than a price that is below the current market price.
This is the safer version of the strategy. Instead of using the current market price as the reference point for your prediction, you use a price that is further in the direction from which you expect the market to move away. This strategy will win you a higher percentage of your trades but also get you a lower payout. Decide for yourself which strategy you want to use.
Strategy 2: Filtering Trends With The RSI
A trend following strategy follows a simple principle:
- In an uptrend, invest in rising prices.
- In a downtrend, invest in falling prices.
Despite this simplicity, many traders are afraid that they might invest in a trend that will end soon. These traders can use the RSI to filter signals.
- When the RSI has mirrored the trend, invest in the trend.
- When the RSI has diverged from the trend, do not invest in the trend.
The addition of the RSI to a trend-following strategy can help traders to win a higher percentage of their trades and make more money with a simple check.
Keep the rest of your strategy unchanged. Use the same expiry as before and invest the same percentage of your overall account balance per trade.
Strategy 3: Trading the MFI’s extreme areas with high/low options
In addition to divergences, the MFI also creates a prediction when a movement enters an extreme area. This prediction allows for a simple trading strategy:
- When the MFI enters the overbought area, invest in a low option.
- When the MFI enters the oversold area, invest in a low option.
The success of this strategy depends on your ability to choose the right expiry. The market will need some time to turn around, which is why you must avoid choosing a too short expiry. When you choose your expiry too long, on the other hand, the movement might be over by the time your option expires.
Experience will help you find the right expiry. The perfect setting depends on the situation, the period of your chart, and the characteristics of the asset. If you are looking for a rough number with which to start, try around 5 periods, and then take it from there.
Similarly to the first strategy, you can also trade this strategy based on the RSI or with low-risk ladder options.
Leading Indicators – Summary
Leading indicators are an important, helpful, and easy-to-interpret tool of market analysis. Binary options traders can use leading indicators as the sole basis of their strategy or to filter signals. They are especially helpful to find the right timing and avoid bad trading opportunities.
What Are Lagging Indicators?
Lagging indicators are an important aspect of any market analysis strategy. This article explains everything you need to know to trade binary options based on lagging indicators. You will also understand their advantages, disadvantages, and ideal fields of use.
The difference between leading and lagging trading indicators is the same.
- Lagging trading indicators tell you what happened to the price of an asset in the past in a way that helps you to predict what will happen next.
- Leading indicators analyse another factor and predict how it will influence the price of an asset.
This difference is why lagging indicators are especially useful during trending periods. When the market is in a trend, lagging indicators can help you make great predictions; but when the market is not trending, many lagging indicators use their predictive qualities.
Lagging indicators serve an important purpose and are a vital part of any market analysis strategy. To see how you can use lagging indicators for your trading, let’s take a closer look at three popular examples of lagging indicators.
Popular Examples Of Lagging Indicators
There are hundreds of lagging indicators, but let’s keep things simple. Here are the three most popular lagging indicators every trader should know.
Example 1: Trends
The most popular example of a lagging indicator is the trend. Trends are the zig zag movements that take the market to new highs and lows.
Trends are zig-zag movements because the market never moves in a straight line. Every once in a while, every movement has to take a break to create new momentum. It is simply impossible for all traders constantly to keep buying.
This is why trends take two steps forward and one step back. The resulting zig-zag movements are easy to identify and allow for accurate predictions.
- Uptrends continually create higher highs and lows.
- Downtrends continually create lower lows and highs.
A trend strategy predicts that the current trend is likely to continue.
- When the market is in an uptrend, trend traders invest in rising prices.
- When the market is in a downtrend, trend traders invest in falling prices.
Some traders also trade every swing in a trend. A swing is a movement from high to low, and by trading multiple swings during a trend, swing traders hope to increase their profit.
Of course, no trend will continue indefinitely. But even with high/low options, you would only need to win 60 percent of your trades to make money. A well-executed trend strategy should easily be able to achieve this goal.
A trend is a lagging indicator because it tells you that the market was in a trend over the last periods. While this knowledge also allows for predictions about what will happen next, the main indication of a trend is based on past price movements.
Trends are also the most important lagging indicator. Most other lagging indicators lose their predictive abilities when the market is not trending, which is why a trend analysis should precede the use of other technical indicators.
Example 2: Moving averages
Another popular example of a lagging indicator is the moving average. A moving average calculates the average price of the last periods and draws it into your chart. It then repeats the process for all preceding periods and connects the dots to a line.
The position and the direction of a moving average can tell you a lot about what the price of an asset has done:
- When a moving average points upwards, the market must have risen over the last periods. When it points downwards, the market must have fallen.
- When the market is trading higher than the moving average, the market must have risen over the last periods. When the market is trading lower than the moving average, the market must have fallen.
When both of these indications point in the same direction, you get a good indication of what is happening.
- When the market is trading above a moving average and the moving average is pointing upwards, the market is likely rising.
- When the market is trading below a moving average and the moving average is pointing downwards, the market is likely falling.
These indications help you to make a better investment decision.
Example 3: Bollinger Bands
Bollinger Bands are a popular indicator because they create a price channel in which the market is likely to remain. This price channel consists of three lines or bands:
- A 20-period moving average as the middle line.
- An upper line two times the standard deviation above the middle line.
- A lower line two times the standard deviation below the middle line.
The market always never leaves the outer two lines of the Bollinger Bands. The middle line works as a weaker resistance or support, depending on whether the market is currently above or below it.
Bollinger Bands can help you to understand whether an asset’s price is likely to rise or fall.
- When an asset is trading near the upper range of the Bollinger Bands, it has little room left to climb any further. Consequently, it is likely to fall.
- When an asset is trading near the lower range of the Bollinger Bands, it has little room left to fall any further. Consequently, it is likely to rise.
- When an asset is approaching the middle line, it is likely to take a break. Sometimes, the market will break through the middle line; sometimes, it will turn around.
These indications provide you with many trading opportunities.
Bollinger Bands are lagging indicators because they only tell you what happened in the past. The moving average and the standard deviation are both based on the last 20 periods. While it is likely that the market will adhere to similar confides for the current period, too, Bollinger Bands are unable to predict the trading range 50 periods from now. Then, the market environment will have changed, and the trading range will be different.
Despite this limitation, Bollinger Bands can be a valuable part of your trading strategy. We will later see how.
Why Should I Use Lagging Indicators?
Some newcomers to binary options question whether lagging indicators can help them at all. They point out that any trader has to predict what will happen next, and argue that indicators that tell you what has already happened are of little help with this task.
These traders are mistaken. Lagging indicators can make valuable predictions and help you gain deep insights into the market. There are two main reasons why traders use lagging indicators:
- Lagging indicators are based on proven facts; leading indicators are not.
- Understanding what has happened helps you predict what will happen next.
Let’s take a closer look at these three advantages of lagging indicators.
Advantage 1: Lagging indicators are based on proven facts, leading indicators are not
When a 50-period moving average is pointing upward, you know that the price of an asset has risen more than it has fallen over the last 50 periods. This result is indisputable. Similarly, when the market is currently trading below the moving average, you know that the market has recently picked up some downwards momentum.
This knowledge puts your trading strategy on solid feet. Especially conservative traders will like lagging indicators because they provide them with a certain basis from which they can make their decisions.
Leading indicators are different. The volume is a leading indicator, for example. A volume strategy predicts that a reducing volume indicates the impending end of a movement. This might be true, but it is not certain, and it is impossible to prove this connection – you have to believe it. While the volume is slowing down, the price movement itself can even accelerate. Sometimes, a reduced volume indicates an ending movement; sometimes it does not.
Simply put, lagging indicators focus on past price movements – which are known. Leading indicators imply that another factor will influence future price movements – you can believe that there is a connection, and there might be, but there are many other factors influencing the market, which is why it is impossible to say whether this connection influences the market at all and whether it will influence the market stronger than other connections.
Advantage 2: Understanding what has happened helps you predict what will happen next.
Lagging indicators also allow for predictions about what will happen next – they just do so indirectly.
Leading indicators imply that a certain factor will decide where the market will go next. Lagging indicators make no such assumption. They simply predict that what has happened before will continue.
When the market crosses a moving average, lagging indicators only tell you what has happened – the market has recently changed direction. The implied assumption is that this movement will continue.
- If the market fell for the last periods, it seems likely that the same factors that pushed down the market in the recent past will also push it down shortly.
- If the market rose for the last periods, it seems likely that the same factors that pushed up the market in the recent past will also push it up shortly.
Both predictions are tradable.
Generally, binary options trading requires you to understand what is happening right now. Since there are so many factors at work right now, it is impossible to say with is happening with absolute certainty. But understanding what has happened is an essential part of arriving at a tradable prediction that will be right in enough cases to make you money.
How To Trade Lagging Indicators
Let’s get concrete. Here are three strategies for how you can trade lagging indicators with binary options.
Strategy 1: Trade Swings In A Trend With One Touch Options
Each trend consists of many swings. Each single swing offers a great trading opportunity for one touch options because it combines strong indications of direction and length of movement.
Every movement in the main trend direction is followed by a movement in the opposite direction and vice versa. This simple relationship makes predicting the market’s direction simple once you recognize a swing.
Now, you could simply trade this signal with high/low options, but swings also allow you to trade one touch options, which offer much higher payouts but require you to predict the length of the movement.
In a trend, swings in the main direction will always move at least as far as the last extreme.
- In an uptrend, the next upwards swing will reach at least the price level of the previous high.
- In a downtrend, the next downwards movements will reach at least the price level of the previous low.
Swings against the main trend direction follow similarly clear rules. The market usually reverses one-third or two-thirds of the previous movement in the main trend direction.
- In an uptrend, a downwards swing will reverse roughly one-third to two-thirds of the previous upwards swing.
- In a downtrend, an upwards swing will reverse roughly one-third to two-thirds of the previous downwards movements.
With this knowledge, you gain the clear price target that you need to trade a one-touch option. Here’s what you do:
- Wait for an ending swing.
- Determine the reach and the direction of the next swing.
- Check whether your broker offers you a one touch option with a target price within reach of this movement and a realistic expiry. If so, trade it. If not, trade a high/low option in the direction of the movement.
At this point, it is important to mention that movements against the trend’s main direction are usually more volatile and take longer to develop. Many traders avoid trading reversals with one touch options and use high/low options instead. Decide for yourself how you want to trade reversals.
Strategy 2: Trade The Market Crossing The Moving Average With High/Low Options
When the market crosses a moving average, it has apparently changed direction. You can predict that this new movement will continue and invest in a high/low option in the direction of the movement.
- When the market crosses your moving average downwards, invest in a low option.
- When the market crosses your moving average upwards, invest in a high option.
The important aspect of this strategy is that you choose the right expiry. For example, a 9-period moving average can never predict what will happen to the price of an asset over the next 50 periods. 50 periods and 9 periods are simply too different time frames.
To avoid making predictions that are impossible to make based on your moving average, always keep your expiry shorter than the amount of time that is the basis of your moving average. Ideally, you would use an expiry shorter than half of your moving average.
Similarly, you should avoid using an expiry that is too short, or short-term market fluctuations could cause you to lose your trade despite making a correct prediction. Use an expiry that is at least one-quarter of the time that is the basis of your moving average.
For example, when you use a moving average that is based on 20 periods and a price chart with a period of 5 minutes, your moving average is based on 100 minutes (20 times 5). Ideally, you would trade this moving average with an expiry of 25 to 50 minutes. You could also go a little longer or shorter, but an expiry of 60 seconds would be too short and one of 4 hours would be too long.
Strategy 3: Trade Bollinger Bands With Low-Risk Ladder Options
Bollinger Bands indicate the market’s trading range, and ladder options allow you to predict which prices are outside of the market’s reach – this is a great combination.
The success of this strategy also depends on choosing the right expiry. Bollinger Bands are lagging indicators, which is why they are unable to predict what will happen ten periods down the road. By then, the market will have changed, and the Bollinger Bands’ indication will have changed with it.
To make sure that the Bollinger Bands in your chart create valid predictions for your option, you have to set the period of your chart to the same value as your expiry or longer. The important point is that your option expires within this period because the Bollinger Bands only create predictions for this period.
When you think about trading an option with an expiry of 15 minutes, you need to use at least a 15-minute chart. If ten minutes have already passed within the current period, you have to switch to a 30-minute chart to guarantee that you option expires within the current period.
All you have to do to execute this strategy is this:
- Set the period of your char to the length of your expiry.
- Analyse the upper and lower price ranges of your Bollinger Bands.
- Find a ladder option with a target price outside these boundaries.
- Predict that the market will be unable to reach this price level.
For example, assume that an asset is trading for £100. The upper Bollinger Band is at £101, and the lower band is at £99.5. Your expiry and your chart period are 30 minutes, and no time has passed in the current period.
- If your broker offers a ladder option with a target price of £101.5, you know that the target price is outside the range of the Bollinger Bands. Consequently, you should invest in a low option based on this target price, thereby predicting that the market will be unable to reach this price level.
- If you broker offers a ladder option with a target price of £100.5, you know that the target price is within reach of the Bollinger Bands. This target price would be a bad investment based on this strategy.
With this strategy, you will get relatively low payouts. Since you should be able to win the overwhelming majority of your trades, you should be able to make a profit nonetheless.
Summary
Lagging indicators are an important aspect of any market analysis strategy. They offer certain indications about what has happened and allow for quality predictions about what will happen next. Strategies based on trends, moving averages, and Bollinger bands have helped many traders create successful trading strategies.
Three Examples Of Strategies For Technical Indicators
To help you get started with binary options and technical indicators, here are three examples of strategies that you can use.
One: Trading The Extremes Of The MFI/RSI
The Money Flow Index (MFI) and the Relative Strength Index (RSI) are simple to interpret technical indicators that are based on similar ideas. Both indicators are oscillators, and both calculate the strength of a movement by relating its current momentum to past momentum. The difference is that the MFI also considers the volume while the RSI focuses on price action alone. Pick the indicator you like better; it will make little difference to your final strategy.
Both the MFI and the RSI define an overbought and an oversold area.
- When traders have bought an asset for too long, the MFI and RSI assume that there are not enough buyers left in the market to continue to drive the price up. The market is overbought and a turnaround likely.
- When traders have sold an asset for too long, the MFI and RSI assume that there are not enough sellers left in the market to continue to drive the price down. The market is oversold and a turnaround likely.
Based on this simple prediction, you can trade a binary option. When your indicator of choice reaches an extreme value, invest in the opposite direction and predict that the market will turn around soon. Some traders also invest when the market leaves an extreme area, arguing that it is better to invest in a reversal that has already happened (as indicated by the market’s leaving the extreme area) than an impending turnaround (as indicated by the market entering the extreme area). Some traders also wait a few periods before they invest and see if the market remains within the extreme area.
Two: Trading Bollinger Bands
Bollinger bands are a great technical indicator for binary options traders because they clearly indicate price levels at which you should expect price actions.
Bollinger bands create a price channel that consists of three lines. Those are:
- A moving average. The middle line of Bollinger bands is a moving average, usually based on 20 periods.
- An upper line. By adding twice the standard deviation to the moving average, Bollinger bands create the upper line.
- A lower line. By subtracting twice the standard deviation from the moving average, Bollinger bands create the lower line.
The result of this process is a price channel that surrounds the current market price. Each line works as a resistance or support, depending on the direction from which the market approaches the line.
- When the price approaches a line from the top, it works as a support.
- When the price approaches a line from below, it works as a resistance.
Traders can trade these lines in two ways:
- Trade the impending turnaround. When the market reaches a line, it will likely be forced to turn around, at least briefly. Traders can trade this prediction and invest in a movement in the opposite direction of the preceding movement. If you are using a high/low option, remember that this is a short-term prediction and use an expiry about the length of one period. You can also use a one touch option. In this case, make sure to use a target price no further than half the distance to the next line.
- Trade the market’s breaking through the middle line. The middle line is special because it can work as a resistance or a support, depending on the market’s current position in relation to the line. When the market breaks through the line, it changes its meaning. What was a resistance now becomes a support, or vice versa. Traders can profit from this significant event and invest in a binary option in the direction of the breakthrough.
This simple way of making money is ideal for newcomers. Experienced traders can also add another indicator to confirm the prediction made by the Bollinger bands, for example a moving average.
3. Trading the Average True Range (ATR)
The Average True Range (ATR) is a technical indicator that is perfect for traders of boundary options. Boundary options are a special type of binary options because they are the only type that does not require you to predict the market’s direction, which is perfect for traders who find this type of prediction difficult.
Boundary options define two target price in equal distance from the current market price. One above the current market price, one below it. Two win your option; the market has to trigger either target price before your option ends. There is no need for it to remain at the price level, and it only has to touch one target price. Boundary options are one touch options with two target prices.
With boundary options, your task is not to predict in which direction the market will move. Your task is to predict whether it will move far enough to reach one of the two target prices. The ATR is the perfect indicator to make this prediction.
The ATR does one simple thing: it calculates the average range of past market periods. If the ATR has a value of 10 and you are looking at a chart with a period of 10 minutes, for example, the asset has moved, on average, 10 points every 10 minutes in the past.
You can adjust the number of periods you want the ATR to analyze. Most traders use a setting of 14 periods, which means that the ATR calculates the average range of the last 14 periods of your chart.
To trade boundary options based on the ATR, you only have to compare the ATR’s reading to the target prices.
Let’s get back to our earlier example: in a chart with a period of 10 minutes, the ATR has a value of 10. If your broker offers you an option with target prices that are 30 points away and an expiry of one hour, you know that there is a good chance that the market will reach one of the target prices. Your reasoning would look like this:
- The market has moved 10 points per period.
- To reach a target price in a straight movement, the market would have to move 5 points per period. (The option has an expiry of 60 minutes and you are looking at a 10-minute chart. This means you have six periods until your option expires. The target prices are 30 points away. Divided by six periods, you get that the market would have to move an average of 5 points per period to get to the market price in a straight line.)
- The market’s average movement per period is twice as high as the necessary movement to reach the target price.
- Generally, the market will never move in a straight line, but if moves in the same direction for two periods in a row, it is almost there. So there is a good chance that it will reach the target price.
As you can see from this example, you will always have to discount the market’s maximum reach. If the market moved in the same direction for 60 minutes, it would have a range of 60 points. This will never happen, which is why many traders use a discount factor. They multiply the maximum reach with 0.5, for example, and when the target price of a boundary option is closer than the result of this equation, they invest.
You can choose the discount factor according to your risk tolerance and experience. We recommend using a factor of 0.5 or lower. Higher factors are too risky.
Also, consider the payout you get for your option. Some brokers offer high-risk boundary options (faraway target prices, higher payout) and low-risk boundary options (close target price, lower payout). Higher payouts allow you to trade profitably when you win fewer trades, which is why you can take more risks and use a higher discount factor.
Some traders also use the Average directional movement index (ADX). The ADX indicates the trend strength on a scale of 0 to 100. 0 indicates a complete lack of direction, 100 that all periods point in the same direction. You can calculate your discount factor by dividing the ADX’s value by 100.
- When the ADX reads 40, you use a discount factor of 0.4.
- When the ADX reads 70, you use a discount factor of 0.7.
With this strategy, you adapt your discount factor to the current market environment.
Final Word On Technical Indicators
Technical indicators and binary options are a great combination. Technical indicators allow you to make short-term predictions in any market; binary options enable you to trade these predictions more profitably than other trade types.
As our examples of the MFI/RSI, Bollinger bands, or the ATR show, there is an indicator for any strategy. Find the right indicator for you, and you have taken a big step towards becoming a successful trader.
If you still need a broker with which you can trade binary options, take a look at our top list of the best brokers;