All experienced traders are aware of moving averages and the best ways of interpreting them, however for beginners to binary options trading, it is important to explain what precisely a moving average is.
A moving average takes the lows and highs of a candlestick and, based on the selected time period, projects a value which can be below, above or at the same point as the current asset price.
The bigger the time period chosen, the stronger the areas of resistance and support given, as this is the primary reason to look at moving averages.
In standard interpretation, as long as the price stays above the moving average, it indicates a bullish market so the trader so place call options. The opposite also holds true i.e. if the price stays below the moving average, a trader should place put options.
How to Use Moving Averages
Multiple moving averages are able to be used on the same chart, with the trader looking for crosses between them to be taken as signs of a bearish or bullish market. When it comes to the expiry date, the time frame that is being analysed is essential to take into account. For example, if an investor is observing a cross between MA50 and MA100 on a monthly chart, it would be pointless to trade with an hourly or end of day expiry date as the market is likely to take them out.
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Moving averages are popularly used by traders as they have one distinct advantage – they are very easy to identify and to use. All a trader needs to know is that they must buy purchase put options in a bearish environment as long as the asset’s price remains below the identified moving average or buy call options if the price stays above the moving average.
How to Trade With Moving Averages
While it sounds simple, trading with moving averages is not as easy as it seems. The first thing a trader must do is select the period on which the moving average will be set up. The period is essential for the expiry date to be used with the chosen binary option. In the case of a short term expiry date, moving averages which are larger than 20 periods will not give many accurate strike prices, so it would be better to choose an hourly expiry date if the moving average appears on a lower time frame such as a 5 minute chart.
The larger the period being taken into consideration for the moving average, the bigger the expiry date needs to be when trading.
Most traders use moving averages as part of a complete trading system, looking at the crosses between slow and fast moving averages to find changes in the market, where it turns from a bearish to a bullish market or vice versa.
A 200 moving average is believed to be the most important as it represents a strong level of resistance or support. Therefore, if the market is below this 200 moving average, rallying into it, on the first test a trader should purchase put options as it is most likely that the price will reject from this area. If there is repeated testing of this 200 moving average, it is likely that a break is likely to occur soon and by the time it breaks above, like any area of resistance or support, the previous resistance will turn into support so call options must be purchased on a further retest.
If the moving averages such as the 200, 100 or 50 cross, it is referred to as a golden cross and is a signal of a bullish market, or a death cross, which is a sign of bearish conditions. It is recommended to purchase call options on a dip which follows a golden cross, while put options are recommended on a dip which follows a death cross.
Moving averages are very popular among binary options traders and there are several kinds of moving averages such as EMA (exponential ones) or SMA (simple ones), however in the end, each type shows the same thing. It is important to have a good understanding of moving averages and how they can be traded in order to maximise success.
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- “The CRISMA trading system: who says technical analysis can’t beat the market?.” Pruitt, Stephen W., and Richard E. White. The journal of portfolio management 14, no. 3 (1988): 55-58.
- Simple technical trading rules and the stochastic properties of stock returns. Brock, W., Lakonishok, J. and LeBaron, B., 1992. The Journal of finance, 47(5), pp.1731-1764.