Utilizing the Moving Average with Binary Options

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Using Moving Averages in Binary Options

What are Moving Averages?

Moving averages (MA and EMA) are indicators that exert their action by smoothing out price action over a specified period of time.

They can therefore be used as a means of predicting future price action. If you look at a chart with a moving average indicator, you can get a sense of price direction from the slope of the moving average indicator.

Generally speaking, it is better to use moving averages that smooth out price action over a longer time frame because they do not respond readily to choppy price movements and so provide more reliable signals.

Of the four types of moving averages, only two should be of concern to the binary options trader. These are:

– Simple moving average (SMA)

– Exponential moving average (EMA)

Moving averages can be used on their own to detect binary options trading opportunities, or they can be used as components of trading strategies in which case, they must be combined with other indicators or other parameters of technical analysis.

Using Moving Averages in Binary Options

Moving averages are prone to fakeouts because of the very nature of their function. The shorter period moving averages respond earlier to sharp price movements, while the longer period moving averages tend to lag with price. So while the moving averages based on shorter time periods can be used to identify new trends earlier, they tend to give many false alarms. If the trader were to rely solely on the longer time frame moving averages, they would only be useful in picking up long lasting trends on the longer term time frames because they lag so much.

Now the above points noted may be of concern to traders who trade forex because in the forex market, profits are a function of how many pips can be garnered, which puts a lot of emphasis on getting in on the trend early. In binary options where a single pip can put the trade in the money, this is less of an issue. Consequently, the trader should primarily be concerned about picking up trend direction.

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This leaves binary options traders the option of using moving averages in the following ways:

a) Using moving average crossovers

b) Using moving averages as dynamic support and resistance tools.

Moving Average Crossovers

If you use the moving average crossover strategy, you are essentially aiming to find tradable points where the faster moving average crosses above or below the slower moving average (you can read our article dedicated to moving average crossover strategy here).

The CALL signal would therefore occur if the faster moving average crosses above the slower moving average, and the PUT signal would be generated if the faster moving average crosses below the slower moving average in a downward direction.

A good combination would be to use a 10 SMA and a 20 SMA. Crossovers must always be traded with confirmation, either with candlestick patterns or some other indicator which would confirm the move in the direction of the crossover.

MAs as Dynamic Support and Resistance Tools

Moving averages move in the direction of the trend, but in this manner, they can also function as dynamic supports (in an uptrend) and dynamic resistances (in a downtrend). We use the words dynamic because the supports and resistance points they form are not at the same static horizontal level, but are constantly changing. In other words, when the price takes a brief retracement, it is expected to bounce off the moving average in an uptrend and retreat from a moving average in a downtrend. The 50 EMA is a good moving average to use for this setup.

For the binary options trader, all that needs to be done is to place a CALL at a dynamic support and PUT at a dynamic resistance. Further confirmation is provided if the candlestick pattern at the dynamic support/resistance supports the move (e.g. a morning doji star at a dynamic resistance in a downtrend).

Assuming there is a break of the moving average, it will change function because such a break indicates a trend reversal. So a broken dynamic resistance will automatically become a dynamic support level, and a broken dynamic support will turn around to become a dynamic resistance.

Moving averages can be used to pick out binary options trades of the Call/Put variety, but they usually require confirmation because they tend to either produce fakeouts or lag behind the market.

More About Adam

Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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