Technical indicators are essentially mathematical instruments that leverage the historical data of an underlying asset to determine potential future trends. Technical analysis entails the use of these indicators to interpret and understand the market.
How To Trade Using Technical Indicators
At the heart of technical analysis are the hypotheses that:
- History is a good indicator of the future because it repeats itself
- The price on an underlying asset is a good indicator of other pertinent factors such as the economy of the country (when trading currencies), the market conditions, or the company (when trading stocks and indices)
- The prevailing market trends impact the price of the underlying asset
One can use numerous indicators to trade binary options. These can be categorized into indictors that are based on:
Trends: These indicators help traders to predict whether the price of an asset will move up or down. The Parabolic Stop and Reverse (PSAR), Moving Averages and Moving Averages Convergence Divergence (MACD) are examples of indicators that help to analyze trends.
Momentum: Momentum-based indicators provide signals based on the speed at which the price on an asset moves. Examples of momentum technical indicators include the relative strength index and the commodity channel index.
Volatility: Technical indicators that indicate volatility essentially signify the extent to which the price of an asset deviates from the prevailing trend. Examples include standard deviation, Bollinger bands and average true range.
Volume: Volume-based indicators signal the amount of trading activity around an asset. Examples of such technical indicators include rate of change and on balance volume (OBV).
Trading using trend-based indicators
The moving average is the most common indicator used to determine the price trends of an underlying asset. Using different moving averages, it is possible to determine the crossover of a short term and long term moving average. A bearish trend prevails in a downside crossover allowing you to buy Put options. Meanwhile, in a bullish trend when there is an upside crossover, it would be an opportune time to purchase Call options.
Trading using momentum-based indicators
Technical indicators that assess the momentum of an asset essentially identify when the prices are too high and when they are too low. When prices are too high it is an indication that the asset is overbought and when the prices are too low, it is an indication that the asset is oversold. When asset prices are rising too high, this offers an opportunity to buy Put options expecting that prices will decline later. On the other hand, when the asset prices are cheap, you could enter into a Call position with the expectation of higher prices later.
Trading using volume indicators
Volume price charts help to indicate the price movement of an asset based on the trade volume on a particular asset. These charts plot a certain price point after a certain amount of an asset has been traded. When the volume of an asset is low, it is an indication of potential price reversals in the event that the trade volume picks up. At the same time, when the volume increases or decreases it could be an indication that the prices of the underlying asset could potentially move up or move down soon.
Tip: A major mistake beginners make is to use the same type of technical indicator on a single chart. This only leads to inaccurate or redundant market information about the asset. The best practice is to use a single type or categories of indicators to analyze an asset. So for example, instead of using trend and momentum technical indicators at the same time, you could use just one or more complementary types of trend-based indicators to make predictions about the price movement of the underlying asset.