Estimating Volatility

As a binary options trader, predicting future price movements often is not enough to win you an investment. For touch / no touch, only predicting the direction will not win you the investment. You also need to predict the distance prices will move. For boundary options, price direction matters even less. You can win the option by investing before a significant price change, regardless of the direction of this price change.

Become better at estimating volatility

Predicting the rate of price change is another, totally different challenge from predicting price direction. If done successfully, however, it will allow you to make a significantly larger profit, as touch and boundary options offer a much higher payout than high / low options.

The rate prices change in is called volatility. In general, volatility means variance and measures the distance of one value from a calculated standard. In technical analysis, volatility measures the distance between prices and some form of calculated mean, such as a moving average. In markets with high volatility prices move faster and further than in markets with low volatility.

Markets with higher volatility are better suited for investing in a boundary or a touch option than markets with low volatility, which lack the energy to push prices far enough. Markets with low volatility, on the other hand, are better suited for investing in a no touch option. Also, volatility is not always guaranteed to work in your favor. If you invested in a touch option in a highly volatile market, the high volatility can make prices turn around and move in the opposite direction. Still, your chances of winning a touch options in a volatile market are far better than in a quiet market.

Traders looking to invest in a touch or a boundary option should therefore search for markets with high volatility.

There are a number of ways to do that:

1) Maximum move

The maximum move is the simplest way of measuring volatility. To calculate the maximum move, you simply subtract the lowest low from the highest high over a given number of periods and track the result.

Luckily, most charting applications can save you from doing this job with pen and paper. When you compare the recent numbers to numbers from the past you can see whether volatility is increasing or decreasing. Additionally, you can see how far the market is likely to move over a number of periods in the current environment, which can be helpful for investing in a touch or boundary option.

2) Bollinger Bands

Of course, the maximum move as a way of measuring volatility lacks a frame of references and makes numbers therefore hard to interpret. Also, if the market moves rapidly up and down in a narrow trading range, the maximum move fails to recognize this kind of volatility, even though it might be well enough to win you a binary option.

To overcome these problems, traders started using the standard deviation. The standard deviation measures how far prices stray from their mean. A number of technical indicators use the standard deviation, most notably Bollinger bands. Bollinger bands multiply the standard deviation by two and subtract and add the result from a simple 20-period moving average, thereby creating a corridor for prices to move in.

You can use the Bollinger bands’ corridor to predict how far prices can move, and whether investing in a boundary or a touch options makes sense in the current market environment. For example, if prices are currently at the lower range of the Bollinger bands and you are expecting a strong price movement upwards, a touch options with a target price below the middle line of the Bollinger bands would be a good investment opportunity, as there is no resistance to stop prices from moving that far.

3) Average True Range

The average true range (ATR) is another technical indicator that helps you predict volatility. The ATR subtracts the low from the high for each period over a given number of periods and calculates the average. If the resulting value is increasing, the market is becoming more volatile. If the number is reducing, the market is becoming less volatile.

You can use the ATR’s value to predict whether a movement can reach the target price of a touch or boundary option. For example, if you expect a strong movement in a certain direction over the next four periods, and your binary options broker offers you a touch options in that direction that’s only twice as far from the current price as the ATR’s value, this is a good opportunity.

If the target were eight times as far from the current price as the ATR’s value, the chances for the market reaching the target price in only four periods were slim, and you should not invest.

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