Binary options trading is simple. Bet that an asset price will be above/below a specific price at a particular time. If you win, you make a profit in addition to your wager. If you lose, you lose your wager.
On the surface, it might look like regular gambling, but it is not. A lot of research and skill goes into making the correct prediction. Technical indicators are one of the tools that traders use to make the correct price speculation.
In this article, we will summarize what binary trading is and highlight the most important technical indicators that you should pay attention to as a binary options trader.
What is binary options trading?
Binary options trading allows traders to make time-bound speculations on an underlying asset. The asset can be shares, currency pairs, indices or even global events. Each binary options contract has an option premium, a pre-determined strike price point, and an expiry time.
The option premium is the fund you use for the bet, while the pre-determined strike price is the figure in which you bet the asset price will exceed or not reach. The expiry time is the time when the contract ends. You earn a profit if your prediction is accurate at the expiry time. If it isn’t lose everything
The need for technical indicators in binary options trading
Traders use technical indicators to examine the price history of an asset. Based on the price history, they can find a pattern or trend which can help them accurately guess the price of an asset at a future time.
However, technical indicators are not crystal balls. They can only provide insight into an asset price movement based on history. They are not definite indicators.
These limitations notwithstanding, traders have come to rely on technical indicators as a reliable way to make the report prediction. When making technical analyses, they generally look at the following factors.
- Price volatility
- The direction of the assessed price moment
They use technical indicators to combine these factors into a readable momentum or trend that helps them predict what the price will be at a later time.
Technical Indicators for Binary Options
Here are the top technical indicators used by experienced binary options traders.
Directional Movement Indicators (DMI)
Wilder’s Directional Movement Indicators (DMI) allow a trader to determine an identified trend’s strength. It consists of three lines: ADX, DI+, and DI-.
With these indicators, traders can determine whether the trend will continue when their contract expires or whether there will be a trend reversal. The trader will take a buy or sell position depending on the strength of the identified momentum and trend.
Pivot point analysis is an essential tool in technical analysis as it allows traders to pinpoint trends within specific timeframes. Since most binary options contracts expire in about five minutes, the Pivot Point indicator and support and resistance zones will help traders identify price movement within that time frame. It is advantageous in analyzing highly liquid markets such as forex pairs.
Commodity Channel Index (CCI)
The commodity channel index (CCI) gives the trader an understanding of how the asset’s current price relates to the average price within a specific timeframe. This insight helps the trader predict if the price will go up or down. For instance, if the difference between the asset’s current price and the asset’s average price is too wide, the trader might predict that there will be a price correction. As such, they will take a position that sees the asset dropping or rising to its average price. Traders also use the CCI to identify emerging trends.
The Stochastic Oscillator indicates whether an asset is overbought or oversold. If the asset is overbought, traders can expect the price to fall. If the asset is oversold, traders can expect the price to rise. As such, this tool can help determine the start of a trend. It is typically used with a 14-day timeframe but binary options traders can apply it to any timeframe.
Limitations of technical indicators
Although technical indicators are valuable to traders, they have limitations.
The first limitation is that they rely on an asset’s price history. While assets generally stay within the same price range, there are times when they break out of their support/resistance zones. These breakouts can cause a binary options trader to lose on a trade.
Furthermore, technical indicators also show a pattern. They do not predict what the price will be. As such, traders must apply their experience to determine if the asset price will reach the pre-determined strike price point by the contract expires.
The Bottom Line
Professional traders use the technical indicators mentioned here to generate trade signals. However, they should be used with caution and constant monitoring. Traders should also apply money management strategies to preserve their capital.