Technical Analysis And The Best Strategies For Binary Options
I have often wondered what the best strategy for binary options is and the only answer I can come up with is the one that works at the time. Technical analysis and binary options trading is not an exact science, it takes patience to master and even them comes with risk. No technical indicator or trading system is infallible, traders should never be surprised at an unexpected loss. The best strategy is to be as prepared as possible for all kinds of market conditions by learning to utilize an arsenal of trading tools and techniques.
Binary options are a great way to speculate financial markets. One of the benefits of choosing binary options is the ease of analysis. With futures, forex or equity options you need to know when, where It is less important to know exactly when, how much or how fast an asset is going to move in price than it is to know simply that it is going to move. Becuase of the simplified nature of the analysis many technical indicators, trading strategies and systems commonly found in other forms of trading are easily applied to binary options trading. I have found that my favorite technical indicators and analysis from equity options and stock trading work very well for binary options.
What Is Technical Analysis
Technical analysis is the scientific and objective study of financial markets and price patterns with the intention of speculation. In practice technical analysis is a form of applied social science. Technical indicators, along with trend lines, moving averages and a host of other tools are used by technical analysts to measure, track and predict market movements. Technical analysis is the core of any trading or binary options trading system. Using TA traders and speculators can predict direction, duration and magnitude of movement allowing for pin point entry and exits. Without TA traders can do little more than guess. There are some great books, videos and other resources available across the internet. The best binary options broker tools, education and resources is at 24Option.
What Is A Technical Indicator
Technical indicators are mathematical models that track price movements of financial products. Indicators are used on stocks, bonds, commodities, currency, indexes and other types of derivative instruments. The models are charted alongside or just under the chart of the underlying asset and are intended to give a deeper view of market strength, direction or volatility. Some indicators use a combination of moving averages while others use price and absolute price changes. Still others may use a combination of data to produce results. Each indicator gives off its own unique signals but they usually fall into one of several categories. These include confirmations/failures, buy/sell signals and convergences/divergences.
Common Types Of Strategies Used In Binary Options
- Trend Following- Bull/Bear, High/Low options, Touch/No Touch
- Range Trading- Straddles, Range Options, Touch/No Touch
- Reversals and Contrarian Trading – High/Low, Touch/No Touch, Range Options
- Hedging and Risk Management- Calls/Puts, Options Builder
Trend Following Strategies For Binary Options
Trend following strategies may be the best for trading binary options. Think about it, binary options pay on the basis of whether an asset moves as predicted or not. What is better than a strategy that follows a clearly trending market? If you know which direction the market is heading and are reasonably sure there is no market stopping resistance ahead trend following strategies are no brainers. Simply take signals in the direction of the trend using your technical analysis to determine the length of time needed for the move to occur. If you are trading signals on a chart of daily bars an end of week or end of month binary option may be the right choice. If you are trading off a chart of hourly bars perhaps an end of day or end of week, if you are using a shorter time frame then intra-day, hourly and 60 second options come into play. The best thing about trend following strategies is that they work well in multiple time frames and can be used for day trading.
My two favorite indicators for trend following are stochastics and MACD. These are two oscillators who got their start in the currency and futures markets. Over time their effectiveness in a wide range of markets has been proven time and time again. Now they are both widely used by traders of all types of financial products in multiple time frames. These indicators are simple to use but do take time to master. They are both effective individually but when used together can produce some really powerful signals. Stochastic is one of the more traditional oscillators and is charted in a range from 0-100 with overbought and oversold levels. MACD can also be charted this way but is more often displayed as a histogram.
Trend Following Indicators For Binary Options Trading
Stochastic Oscillator - The word stochastic derives from the ancient Greek and means “random” or “up to chance”. The indicator is based on Random Walk and Chaos Theory. It assumes that while the nearer term direction of the market is hard to determine you can use that movement to determine the overall trend. Imagine this, a man is walking his dog down the street. The man is in control of the dog by the leash. The dog may bounce around, walk from side to side and try to pull the man of his chosen path. The action of the dog is not predictable but based on the trend of his movement we can see that the mans path continues down the street. The same can be said of the market. The day to day reaction of the markets to news and events is hard to predict but over time we can measure that movement and use it to predict which direction and how strongly a market is moving. The stochastic oscillator can give off many kinds of signals. It can generate buy and sell signals in a trending market, it can predict market reversals through divergence, it can confirm breakouts or failures of support and resistance, and determine overbought/oversold conditions. It is also possible to apply chart patterns like head and shoulders or double tops to stochastic.
MACD Histogram – MACD (Mack Dee) stands for Moving Average Convergence Divergence. It is a measure of the converging and diverging of two moving averages. Typically MACD is set to 12,26,9; this means formula consists of the difference between a 12 bar and 26 bar moving average smoothed by a 9 day moving average. The results are displayed in a histogram that produces signals in several ways, zero line crossovers and convergence/divergence are my two favorites. MACD is a momentum indicator and is used to measure the strength of a market.When a market is bullish the short term MA will be above the long term MA and produce bullish peaks, the reverse is true when the market is bearish. This does not mean that there will not be bearish peaks in a bull market or bullish peaks in a bear market just that you should pay more attention to the peaks in relation to the trend.
A series of bullish peaks with each higher than the last is a sign of strength and that the market is likely to keep moving up. This is known as convergence. If the series of MACD peaks were to get lower while the market was making new highs that would be a sign of weakness and possible reversal, also known as divergence. While the market is trending, regardless of the size of the peaks, trades may be taken in line with the trend whenever MACD crosses zero. In a bull market MACD must cross zero from below and in a bear market it must cross from above. If MACD is diverging caution is needed but if it is converging then more aggressive trades could be place.
Support/Resistance Lines - Support and resistance lines are areas where price movements are likely to change or continue. Market peaks, troughs and congestion areas are good places to draw these lines. Up and down trend lines can also be support or resistance and should be included in this part of analysis. I draw my first set of lines on the charts of weekly bars to determine long term trends and possible areas of support and resistance. The most effective lines connect three points but two is usually enough. I often draw lines from congestion areas, market tops and significant technical levels like necklines and shoulders. I always draw these lines with the right edge projected out to the future.
After I use the weekly charts I drop down to daily bars. If any of my long term lines are still present I know that they are going to be the most likely target for support and resistance. I also look on this chart for other likely areas of shorter term support/resistance and draw lines here as well. It is helpful to use different color lines for each time frame to keep them easily identified. The second set of lines are especially helpful if they coincide with a longer term line, moving average or other technical level. These levels are good targets for bounces, beak outs, break downs and reversals.
What Is Range Trading
A trading range is when an underlying asset is trading between an identifiable upper and lower limit. Ranges are marked by multiple tests of both limits over a period of time. Ranges can occur in any time frame and thus are an attractive trading strategy for many professional binary options traders. There are many reasons an asset may be in a range. Traders and investors may have lost interest in the asset. There may be a rotation from one set of buyers to the next or there could be strong and opposing views of what the true value of the asset is. Whatever the case, ranges are great opportunities for big profits. The problem sometimes though is identifying the range early enough to trade on it. Anticipation is the key here and this is one area where utilizing multiple time frames comes in really handy. Binary options traders have a couple of tools for range trading that even include range binary options.
Markets do not have to be trending strongly in order to be profitable. Range trading is a group of techniques that helps traders take advantage of these market conditions. Skilled binary options traders can utilize ranges to produce combination trades that include calls and puts that are both in the money or apply there analysis to range and touch/no touch binary options. Technical indicators like MACD and stochastic are useful in ranges. However, when used alone they can produce a lot of whipsaws and false signals in a sideways trending market.
To help alleviate unnecessary losses a couple of other techniques can be used to help determine support/resistance and where the range boundaries are likely to be. Support/resistance lines, Fibonacci Retracements and Channels are only a few of the means available. I primarily use support/resistance lines, trend lines moving averages and Fibonacci. I have found that if I try to include to much the charts get messy and become hard to read.
Market Reversals, Divergences And Contrarian Trading
With most forms of derivative trading market reversals, divergences and contrarian trading are attractive because of the huge potential for profits. Imagine if you were short S&P 500 futures when the market dropped an unexpected 36 points? Since binary options only pay a fixed amount this type of trading is not as attractive. There is no chance of a huge gains and it carries more risk. Trying to predict tops and bottoms is like trying to catch a falling knife. It is much better to wait for the bottom than try to guess where it is. Even with the added risk market reversals, divergences and contrarian views are still highly tradable but I do not recommend them for novices. One touch options are good vehicles for capturing this type of move.
Market Reversals – Financial markets don’t trend in a straight line and they don’t reverse in a straight line either. Reversal patterns like the Head&Shoulders, Double Tops, Island Reversal and Blow Off Tops don’t happen in one day or one candle. When these types of patterns begin to appear, especially in conjunction with support or resistance, they can be used to accurately predict market direction. Reversals can occur in any time frame and are useful tools for day trading and range trading. The shorter the term of the chart the shorter the significance of the reversal so be sure to utilize multiple time frames to identify the longer term support/resistance levels.
Divergences - Divergences, as I described earlier, are when an indicator such as MACD or stochastic fails to make a higher peak when the underlying asset makes a higher peak. This lower peak is a sign of weakness, slowing and potential reversal. The caveat is that divergences don’t mean a reversal is coming now or tomorrow, just that the market is weakening and one is possible. It is common for a strongly trending market to diverge with an indicator for multiple peaks as it slowly loses steam. The best way to trade divergences is when they appear in multiple time frames at once, what we call a “convergence of divergence”. Divergences can be used to predict reversals and ranges when used along with some form of support/resistance tool. If a divergence appears while the underlying asset is approaching a potential area of support/resistance that is a strong candidate for reversal it increases the likelihood of reversal.
Contrarian Trading- Contrarian trading utilizes a combination of all these techniques to come up with a signal to trade against the market. Trading against the market is one of those things advisors will always tell you not to do and they are usually right, except when they are all right. This is true of the market as well. Contrarians use oscillators, trend lines, support/resistance, Fibonacci’s and a lot of experience to predict when a market is going to reverse. Entries are based on the assumption that the last possible market participant has entered the market and that there is now no where for the market to go but in the reverse direction. If there are no more sellers than the market will go up, if there are no more buyers than it will go down.