Moving Average in Binary Options

In binary options trading, it is essential for the binary options trader to have a basis on a Call or Put action. Different techniques are used to make an informed decision. Some may rely on just financial news and world market trends. Others employ more sophisticated formulas to predict the movement of the price of a specific asset. No matter what technique is used, the risk of a binary options trader is greatly reduced when proper analysis is made.

Technical analysis has been used by binary options brokers since it came to the market a few years back. Traders have seen the invention of hundreds of indicators which they factor when they purchase binary options. Some technical indicators are more popular than others. Some may be objective to some traders. But reliable and useful analysis techniques such as the moving average is preferred over the others by newer binary options traders.

Moving average is exactly what its name implies. It denotes the average of the price movement of an asset for a specific period of time. Moving averages have different derivatives. But, their underlying purpose remains the same. The purpose of moving averages (hereon referred to as MA) is to help binary options traders track the trends of financial assets by smoothing out the day-to-day price fluctuations, also called noise. When the daily fluctuations are disregarded, a more direct trend results, and a general action or direction can be traced from the curve.

By identifying trends using MA, traders are able to make those trends work in their favor and increase the number of winning trades. A clear understanding of why moving averages are important is what the binary options trader needs in order to appreciate the technique. How they are calculated is what will be discussed here.

Simple Moving Average

Moving averages are a common way to gauge the direction of a current trend. Every type of MA is a mathematical result that is calculated by averaging the number of past data points. Once the average is determined, it is then plotted into a chart. This would allow binary options traders to look at smoothened data rather getting confused with the the day-to-day price fluctuations that are inherent in all financial markets.

The simplest form of a moving average is aptly known as a simple moving average (SMA). This type of moving average is computed by taking the arithmetic mean of a given set of values. For example, to calculate a basic 10-day moving average you would add up the closing prices from the past 10 days and then divide the result by 10.

Say we have these following value points:

12, 10, 7, 8, 7, 10, 10, 8, 9, 13, 7, 6, 9

From the above given set of values, the sum of the prices for the past 10 days counting from the rightmost value (9) is 87.

8 + 7 + 10 + 10 + 8 + 9 + 13 + 7 + 6 + 9 = 87

This sum is divided by the number of days (10) to arrive at the 10-day average.

87 / 10 = 8.7

If a binary options trader wishes to see a 50-day average instead, the same procedure would be made, but the sum would be divided into 50 to include the prices over the past 50 days. The resulting average from our example, 8.7, takes into account the past 10 data points. This gives the binary options trader an idea of how an asset is priced relative to the past 10 days.

So why is it called a “moving” average if it’s just plain average. Because, as new values arrive, older data points will be dropped from the set to make way for the new values. Thus, the data set is constantly “moving” to account for new data as they becomes available.

This method of computation ensures that only the most current information is being accounted for. Here’s the continuation of our example. Say a trading day closed adding a new value (12) to our history.

12, 10, 7, 8, 7, 10, 10, 8, 9, 13, 7, 6, 9, 12

Once the new value of 12 is added to the set, the past 10 data points now includes the 12 and drops the first 8. The new count of 10 data points now start from 12, changing the sum.

7 + 10 + 10 + 8 + 9 + 13 + 7 + 6 + 9 + 12 = 91

Because of the relatively larger value of 12 replacing the lower value 8, a binary options trader would expect to see the average of the data set increase. In our example, the SMA went from 8.7 to 9.1.

91 / 10 = 9.1

After obtaining the different SMAs, they are plotted in a chart and connected together to create a moving average line. You will be able to find these curving lines on charts that technical traders use.

Exponential Moving Average

The Exponential Moving Average (EMA) is a type of moving average that gives more weight to recent prices to make them more responsive to new information. Don’t get intimidated by the equation as it is widely used and mastering it is not really necessary since nearly all charting platforms do the computations for you. However, for purposes of discussion, the EMA equation is:

EMA = (P * a) + (Previous EMA * (1 — a) )

where:

  • P — Current Price
  • a — Smoothing Factor = 2 / (1 + N)
  • N — Number of Time Periods

From the formula, we notice that when we calculate the first point of the EMA, there is no value available for the Previous EMA. This can be resolved by obtaining an SMA and continuing on with the above formula for EMA. Traders usually use simple spreadsheets that are available in the Internet that includes real-life examples of how to calculate both a SMAs and EMAs.

Also, by looking at how the EMA is calculated, it can be found that more emphasis is placed on more recent data points, making it a type of weighted average. EMA responds more quickly to the changing of prices. This means that for a certain time period, the EMA has already forecasted that a price would go down while the SMA would still need to go through more periods for find the prices falling. This responsiveness is the main reason why more binary options traders prefer to use the EMA over the SMA.

The use of EMA charts has helped binary options traders forecast trends and directions based on moving average values. The EMA is used in many strategies, so it is recommended to master reading EMA charts. How to use these values to set up trend forecasts is what many charting platforms provide.

Some binary options brokers also provide charts that show moving averages. See our list of binary options brokers, and choose one that you are most comfortable with. Let us help you in your way to success.

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