The Most Important Technical Indicators for Binary Options.
Welcome to binary options. All or nothing, one or zero, these securities are available on Nadex. Binary options allow traders to make time-bound conditional bets on predefined values of stock indices, forex, commodities, and events. Like a standard exchange traded option, each binary option has an option premium ($45, $81, and $77 in the examples above), a pre-determined strike price ($1,700, 8600 points, and 108 yen), and an expiry (1:30 p.m., 2 p.m., 3 p.m. today).
The differentiator is the settlement price that remains fixed at $0 or $100, depending on the option condition being fulfilled. It keeps the net profit (or loss) fixed. The option premium also remains between $0 and $100. (Related: Guide to trading binary options.)
Calculating Probability.
Since binary options are time-bound and condition-based, probability calculations play an important part in valuing these options. It all boils down to " What is the probability that the current gold price of $1,220 will move to $1,250 or above in the next four hours?" The determining factors include:
Volatility (how much, and is it sufficient to cross the threshold/strike price?) The direction of the price move Timing.
Technical indicators suitable for binary options trading should incorporate the above factors. One can take a binary option position based on spotting continued momentum or trend reversal patterns. Let’s look at some of the popular binary option technical indicators.
Wilder's DMI (ADX)
Composed of three lines, namely ADX, DI+, and DI-, and their relative positions, Wilder's Directional Movement Indicators (DMI) Average Directional Index (ADX) aims to capture the strength of an already identified trend. Below is the table for interpreting the trends.
Position.
Momentum.
ADX Value > 25.
ADX Value - \text >\right ) \\ &\textbf \\ &\text = \text \\ &\text = \text \\ &\text = \text \\ \end _ %K = 1 0 0 ( H14 _ L14 C _ L14 _ ) where: C = most recent closing price L14 = low of 14 previous trading sessions H14 = highest price traded during same 14-day period _
Levels above 80 indicate overbought, while those below 20 indicate oversold.
Bollinger Bands.
Bollinger bands capture an important aspect of volatility. They identify upper and lower levels as dynamically generated bands based on recent price moves of a security.
Commonly followed values are 12 for simple moving average and two for a standard deviation for top and bottom bands.
Contraction and expansion of the bands indicate reversal signals that help traders take appropriate positions in binary options. Overbought situations are indicated if the current market price is above the top band. While overselling is indicated when the current market price is lower than the lower band.
A challenge in binary options trading is correctly predicting the sustainability of a trend over a given period. For example, a trader may take the right position for an index, predicting it would hit 1,250 at the end of a five-hour period, but the level was achieved in the first two hours. Constant monitoring is needed for the rest of the three hours if the trader plans to hold the position until expiry, or a predetermined strategy should be executed (like squaring off the position) once the level is reached.
The Bottom Line.
The technical indicators discussed above should be used for timely actions with constant monitoring. One major disadvantage with technical indicators is that the results and calculations are based on past data and can generate false signals. Traders should practice caution with detailed backtesting and thorough analysis for high-risk, high-return assets like binary options.