Reading Moving Averages in Binary Options

As we have established time and again, technical analysis is needed to have successful binary options trades. Binary options traders use moving average to smoothen a trend line showing only the averages of price values for a specified period of time. While day to day charts may show detail as to how a trading day went, moving averages are easier for the binary options trader to look at. Trends can be better established, and more informed decisions can be made.

In the previous article we have discussed how moving averages are computed. Simple moving averages take the mean of the price values at a certain time period while exponential moving average takes the “average of averages” making this type of moving average more adept in finding specific trends for a period.

After knowing how moving averages are obtained, we now look into what to make of these averages. By knowing what a trend line looks like, forecasting price movement becomes more accurate. Binary options brokers provide different tools to see moving averages of different assets. It is up to the binary options traders to perform technical analysis on this charts in order to make the right prediction.

What to Look Out For in Moving Averages

We have come across a more effective way to see price movement and direction. With moving averages, Moving averages are used in binary options for the following purposes:

  • Identifying trends and reversals
  • Provide a measure for an asset’s momentum
  • Identify potential areas of support and resistance

Before we take a look at how to use moving averages in technical analysis for binary options, let us define the terms listed above.

Trend

A trend is simply the general direction and steepness that a price value is moving. In other words, if we collectively take all the values of daily trades, take the moving average, and see a common pattern in the increase or decrease of average value, then we are analyzing a trend. Another definition of a trend may be the tendency of a price asset to move upwards or downwards over time.

Reversal

A reversal occurs when there is a change in the direction of a price trend. A reversal can easily be seen on a price graph, where the line undergoes a recognizable change along its path. An uptrend, which is a series of highs, can reverse into a downtrend by changing to a series of lows. A downtrend, which is a series of lows, can also result to a reversal to an uptrend by changing to a series of highs. A reversal can also be called a rally or a correction.

Momentum

Momentum is a measure of how fast an asset’s price is accelerating. The idea of momentum covered by two concepts, trend and volume. An asset price is said to have a great negative momentum if there the volume is great but a long put spread occurs. Inversely, an asset price has great positive momentum if there is a great volume in the long call spread. In technical analysis, momentum is considered an oscillator and is used to help identify trendlines.

Support

Support is a level in a price history where the price of an asset tends to find break as it is going down. This means the price is more likely to “bounce” off this level rather than break through it. However, once the price has passed this level, by an amount exceeding some noise, it is likely to continue dropping until it finds another support level. Alternatively, support is the price level which, historically, a stock has had difficulty falling and is constantly level or rising. It is thought of as the level at which a lot of buyers tend to enter the stock.

Resistance

Resistance is point or range of points in a chart history that limits an increase in the level of the price of an asset over a period of time. An area of resistance may denote that an asset price is finding it too difficult to break through, and may head lower in the near future. The more times that the price value of an asset has tried to break through the resistance barrier unsuccessfully, the more formidable that area of resistance becomes.

Reading Moving Averages

Graphing moving averages can indicate trends. Trends are the most basic indicator that many binary options traders use. If a moving average shows that a price of an asset is continually going up, or an uptrend, then it must still go up in a certain, perhaps short period of time, and vice versa. Trend following is “going with the flow”. Unless something significant happens like news of a merger or a sudden price change, binary options traders use this flow to their advantage.

Uptrends and Downtrends in Binary Options

An asset price is said to be in an uptrend when the price is above a moving average and this average slopes upward in the chart. Conversely, a downtrend is when the price of an asset is below a downward sloping average. Many traders may consider a long hold, where a continuous uptrend or downtrend can earn a lot of profit. This simple rule has helped many binary options traders to ensure that the trend works in their favor. Beginner traders also use this favorite technique because it is a somewhat standard procedure.

However, moving averages are lagging indicators. This means that their occurrence does not factor in the value of the next trade. In other words, they are unable to predict new trends. But, moving averages can confirm trends that have already been established. So, going along with the trend according to the moving average might be your best bet and your risks are also significantly lower. Unless you gain information that a major reversal might happen, there is a lesser probability that this trend would go the other way.

Slow/Fast Momentum Trading

Another strategy in using moving averages for binary options trading is monitoring the time periods that are covered in the computation of the moving average (10 days, or 50 days in the example in our previous article), and try to notice a pattern that may show the strength of a certain asset price. Generally. short-term trades are less than 20 trades while long-term trades are those that happen in a month or more.

For short-term trades, less volume is traded so momentum is also less. Long-term trades allow for more trades to be factored in the average, so the momentum is also greater. This direct proportionality can help the binary options trader in deciding whether a lower momentum is more advantageous to him than a higher momentum trading environment, or vice versa.

This decision also greatly depends on the amount of investment, the trader’s goals, and the risks involved. For example, if you have a small investment that is very liquid and you want a quick profit out of it, you might want to have a high-momentum trading scenario where you can earn the most profit. Fortunately, binary options brokers offer customizable option builders so the trader can take advantage of this nature of trading.

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