Traders with some exposure to the binary options markets have probably come across the term Technical Analysis when reading the educational materials offered by brokers. Many new traders, however, are surprised when they hear that binary options positions can be based entirely on the price patterns and the historical market behavior that can be found on charts.
But the fact is that technical price analysis is used by a wide majority of the active market community and when approached correctly, technical analysis can enable traders to identify new opportunities that might not otherwise be visible. Here, we will look at what price analysis is and the way it can be used to construct trading ideas and enhance the probability that individual positions unfold in a favorable (profitable) way.
Defining Technical Price Analysis
At its core, technical analysis is a way to evaluate the true value of an asset by analyzing historical price behavior as it is represented on a chart. A technical analyst is not interested in economic data, projections for future corporate earnings or even the identity of the underlying asset. All a technical analyst is watching is the way in which prices have behaved in the past, and this information will be used to forecast how prices are likely to perform in the future.
Since technical price analysts look at the historical performance of an asset (and believe that this performance will be replicated in the future), traders use this approach to define specific price levels that define trades place in active markets. When trading binary options, this essentially means that traders can use technical analysis to create a broad directional forecast (prices moving either up or down) and exact strike prices for executed positions. This information can be critical when defining your parameters for individual trades.
Gauging Supply and Demand
One of the ways Technical Analysis is most useful is in showing areas where basic levels of supply and demand are likely to present themselves in the future. As always, we must remember that excessive supply pushes prices lower, while excessive demand pushes price higher.
If we look at a price chart, see that prices are trending higher, and reach a plateau before reversing, we can see that excessive supply in hitting the market. If prices move upward toward this level again in the future, we would expect a similar market reaction (a downward reversal) and this would be viewed by technical analysts as a prime area for entering into PUT options for that asset.
Conversely, when prices are trending lower (and reach a major trough before reversing), we can see that excessive demand is entering the market as investors look to buy the asset at cheaper prices. If prices move downward toward this level again in the future, we would expect a similar market reaction (an upward reversal) and this would be viewed by technical analysts as a prime area for entering into CALL options for that asset.
Indicators and Oscilattors
The second way traders approach technical analysis is through the use of indicators and oscillators. In the most basic sense, these tools run prices through mathematical formulas in order to determine when an asset has become oversold (become overly cheap) or overbought (become too expensive). These tools are most useful for traders because they allow us to look at price activity in an objective way (without the human error that is associated with other types of forecasts).
For these reasons, most active traders implement some type of indicator or oscillator analysis before any binary options positions are established. Some of the most popular examples of this include the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD), or the Stochastics oscillator.
Past Price Performance to Forecast Future Direction
Technical analysis methods can prove to be a highly valuable when traders are looking to determine which ways an asset is likely to trade in the future and at which levels reversals will be seen. When traders focus on the historical price behavior of a single asset, it becomes much easier to assess the value of a stock, commodity or currency in an error-free manner. For these reasons, technical analysis has become an increasingly popular staple of the market trading community.