Because binary options traders are not concerned with how much an asset moves in price, only the direction, a knowledge of Moving Averages is highly effective in identifying short term price movements for profitable trading signals.
What are Moving Averages?
Used as a technical indicator which assists traders in smoothing out price action by filtering out the ‘noise’ from breakout price action, Moving Averages shows the average value of a stock’s price over a period of time giving weight to each daily price. Used as a lagging trend following indicator which can assist in identifying support and resistance levels as well as producing buy (call) and sell (put) trading signals, Moving Averages does not predict price direction but rather defines the current trend.
Simple to calculate and easy to interpret, when the Moving Average line is rising the trend is considered bullish. If the Moving Average line is falling the trend is considered bearish, while a sideways Moving Average line indicates a flat trendless market.
Type of Moving Averages
There are a number of types of Moving Averages including Simple, Exponential, Variable, triangular, Weighted and Smoothing all of which give different weighting values to each price period. The two most basic and commonly used Moving Average indicators are Simple Moving Average and Exponential Moving Average.
A Simple Moving Average (SMA) shows the average value of a stock’s price over a period of time giving equal weight to each daily price, while an Exponential Moving Average (EMA) places greater weight on more recent data and is therefore considered more reactive to recent price changes than the Simple Moving Average.
Moving Average Timeframes
The most commonly used Moving Average timeframes are the 10-day, 50-day and 200-day. The 200-day Moving Average is used to measure the long-term trend, while intermediate price trends are identified using a 50-day Moving. A 10-day Moving Average is used for short-term price trends.
Fast and Slow Moving Averages
Traders consider Moving Average timeframes to be ‘fast’ or ‘slow’. A fast Moving Average is a short-term Moving Average (such as a 5,10 or 25-day period). A short term Moving Average is faster because only price action occurring over a short period of time is calculated and is therefore more reactive to daily price changes. A long-term Moving Average (such as a 50 or 200-day period) is deemed slower as it references price action over a longer period with considerably more lag, however price noise is noticeably smoothed (as opposed to short-term Moving Averages).
Moving Averages Crossovers
The Moving Average Crossover strategy is a valuable tool for binary option traders. Not only is the strategy reliable, it is simple to execute with clear call (buy) and put (call) trading signals. The strategy is considered to be high-probability yet relatively low risk.
For short-term traders, relying on two individual Moving Average indicators to identify shifts in momentum and generate trading signals, a ‘slow’ Moving Average such as the 20 or 22-day EMA and a ‘fast’ moving average (5 or 6-day EMA) are plotted on top of the price movement of a stock, with crossovers between the slow and fast EMA’s generating buy (call) or sell (put) signals. For binary traders, a call signal is generated when the short-term Moving Average crosses above the longer-term Moving Average, while a put signal is triggered by a short-term Moving Average crossing below a longer-term Moving Average.
Shorter term Moving Average crossovers also serve as a support and resistance indicator, used to identify short-term price targets and key levels.
Golden Cross and Death Cross
Long-term Moving Average crossovers are of greater significance than short-term crossovers when identifying a major shift in market sentiment. Traders use a ‘golden cross’, which occurs when the 50-day Moving Average rises above 200-day Moving Average as a bullish (buy) signal. A ‘death cross’ is considered a bearish (sell) sign and occurs when the 50-day Moving Average drops below 200-day Moving Average.
As opposed to short-term Moving Averages, price is often trapped between medium and long term averages, whipsawing between price extremes presenting ideal trading opportunities for binary option swing traders in this zone. Once penetrated, the 200-day MA begins to act as a major resistance level after the medium-term average drops below it, and major support following an upward breakout.
Advanced Moving Average
While Moving Averages are useful on their own, they also form the basis for other indicators such as Moving Average Convergence/Divergence (MACD), Bollinger Bands and McClellan Oscillator.
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