A moving average defines the mean price movement of an asset over a given period of time. In binary options, traders use moving averages to monitor price trends as the underlying asset undergoes price fluctuations. The moving average does not take into consideration the fluctuations though, to offer an accurate picture of the price direction of the underlying asset.
How to Trade using Moving Averages
For example, a 15 bar simple moving average is formed by plotting the price of the underlying asset over the last 15 trading sessions. The 9, 15, 30, 50, 150 and 200 bars are the most popular. While each trading session is added to the list, another one is dropped off at the end of the sessions to allow the moving average to move side by side with the direction of the asset. This is how the moving average indicator derives its name.
How is the Moving Average Applied?
Traders can set the moving average to varying time frames and thus anticipate varying signals. You can do this by changing the number of bars that are required to calculate the prevailing moving average on the platform you are using to trade binary options.
In essence, a moving average is a mathematical calculation that is arrived at by taking an average of the total of the past bars and then plotting them onto a chart. This approach allows you to eliminate false signals by only focusing on the actual price movement and not on the price fluctuations.
There are two types of moving averages:
- Simple moving averages
- Exponential moving averages
The simple moving average is calculated by taking the average of a given set of prices. So for example, to calculate a simple 15-day moving average, you would take the total of the closing prices within the past 15 days and divide this by 15. The result gives you an idea of the average price of an asset over the past 15 days.
Remember that as new data points are added onto the sequence, new information is loaded to ensure that the moving average accounts for the latest data and thus offers accurate price trend signals. The results of the day’s moving averages are then plotted onto a chart to form a moving average line as found on technical charts.
The exponential moving average focuses more on new price points to offer far more accurate price trend signals. In a sense, the exponential moving average is a weighted average due to its emphasis on recent price data. This moving average is more responsive to the rapidly changing prices on the financial markets. It is common to find that the exponential indicator has predicted the price movement of an asset long before the simple indicator makes such a prediction. As such, traders prefer to use the exponential indicators due to its accuracy compared to the simple indicator.
Trading with the exponential moving average
The exponential moving average (EMA) strategy of trading binary options is better explained using an example. Say, you use a 30-day chart for trading; the underlying trend will be established by a longer first time-frame than the second. If you were using a 24-hour chart and the price of the asset is trending over the 30th bar, then this would be described as a bullish trend and would be considered bearish if the price were trending below the said bar.
It is important to monitor the price movement at any given time with regards to the long-term price trends. In effect, if the price of the underlying asset is higher than the moving average, it is likely that the asset will encounter resistance soon. Whether you are using the EMA or any other strategy, you want to determine when the prices will encounter support or resistance.
As long as you are able to determine that the price trends will not encounter resistance, you can proceed with your trading by monitoring the 30-minute bars. Assess the price trends of the past two weeks to get a sense of the previous price trends in comparison to the price trends of the recent 2 or 3 days. This comparison will allow you to determine support and resistance levels.
The EMA technical indicators will issue a signal every time the price of the underlying asset goes off or moves higher than the 30 bar moving average on the 30-minute chart. It is recommended that you choose an expiry that is between 1 to 4 hours to allow the formation of a signal. In a bullish market, the best time to buy your position is when the price of the asset goes above the 30 bar or bounces off from beneath the bar and undergoes a retraction.
All in all, mastering the EMA strategy is far more pertinent than relying only on the simple moving average strategy to trade binary options.