Indicators can help you understand what the market will do next. Learn more from our guide “What is an indicator?” and become an expert trader.
Instead of losing money with ineffective guesswork, you can use indicators to find profitable trading opportunities and make money with binary options.
If you know the right indicators, trading will become incredibly easy for you.
In this guide, we explain what indicators are and how you can use them for your trading. In detail, we will answer these questions:
- What is an indicator?
- Which types of indicators are there?
- How can I use indicators for my trading?
- What are the limitations of indicators?
- Should I use leading or lagging indicators?
With the answers to these questions, you will be able to find the indicators that can help you become rich with binary options.
What is an indicator?
An indicator is a tool that helps you to predict future market movements. This definition might sound generic, but it excludes many of the things many people commonly consider to be indicative of future market movements.
- Economical data is not an indicator. Many people think that the market will rise or fall in reaction to good or bad economic data, but these events are less connected than they seem. The market often rises in reaction to bad news or falls in reaction to good news, and even if the market reacts in the way you expected, you are unable to predict how far the market will move. Economic data is a bad tool to predict market movements.
- News events are not indicators. Many people think that the market will rise or fall in reaction to news events, but this connection is as fragile and unreliable as the connection to economic data.
There are many more aspects we could list that are widely believed to be indicators but actually say very little about what an asset’s price will do next.
To predict what the market will do, you need a tool that helps you to understand what traders think.
- The market does not rise in reaction to positive news events or economic data; it rises when traders feel good about a news event or economic data.
- The market does not fall in reaction to negative news events or economic data; it rises when traders feel bad about a news event or economic data.
The only thing that determines market movements is the relationship between supply and demand. To predict how this relationship will develop, you have to get inside of the head of the other traders; you have to understand whether they are currently more willing to buy or to sell, and how these actions will affect the market price.
Indicators help you with this task by analyzing past market data and displaying it in a way that helps you to predict what will happen next.
To understand the basic principle behind indicators, consider this example: If you knew that a person has been stopping at a gas station every weekday and that today is a weekday, it would be reasonable to predict that this person will stop at a gas station today, too. You might not be right all of the time, but out of 100 predictions, you would win at least 90. This is how indicators work.
Indicators do the same thing. The relative strength index (RSI), for example, compares the number and the size of past rising periods to past falling periods. It then plots the result in a chart with a maximum of 100 (prices rose only) and a minimum of 0 (prices fell only). The current value can tell you a lot about what is going on in the market.
The logic behind the RSI is simple:
- For the market to rise, more traders have to buy an asset than to sell it.
- For the market to fall, more traders have to sell and asset than to buy it.
When the market rose or fell strongly for a long time, all traders that are willing to invest in this movement already have invested in it. Consequently, the movement will weaken, some traders will take their profits, and the market will turn around. This is why the RSI defines any reading over 70 as an overbought market environment and any reading below 30 as an oversold market environment. When the market has reached these extremes, you know to be careful before you trust a movement.
In this way, the RSI helps you to discover weakening movements you should be careful to invest in. With this knowledge, you can avoid bad investments and find trading opportunities for new movements.
No economic data or news event provides you with a similar insight into what is happening in the market. This is the beauty of indicators:
- Indicators help you understand every market movement, even if there are no news about the asset.
- Indicators help you to see inside the head of the other traders, even though you have never met them.
- Indicators help you to understand the relationship between supply and demand, the only thing that determines whether prices rise or fall.
Indicators are the only tool that can help you with these tasks, which is why they are an essential feature of every successful binary options strategy.
Which types of indicators are there?
While indicators all aim to achieve the same goal, they approach this goal in very different ways. There are many different forms of indicators, each of them ideal for a specific task and the personality of traders that matches this task. To understand which indicator is right for you and the strategy you are trading, here are the indicators every binary options trader should know.
The most fundamental type of indicator is candlesticks. Candlesticks are a form of displaying market movements in a price chart. Each candlestick aggregates an adjustable period of market movements. Candlesticks form simple and complex candlestick formations that allow you to anticipate what the market will do next.
The market moves in trends. Trends are zigzag movements that take the market into a certain direction by creating consecutively higher (in an uptrend) or lower (in a downtrend) highs and lows. By recognizing these trends and profiting from them, either as a trend follower or a swing trader, you can make accurate and reliable predictions about future market movements.
Resistance and support levels
Resistance and support levels can set strong limitations to the market movements: They work as barriers the market cannot break through. Recognizing these barriers can provide you with great insight into what will happen next.
Continuation patterns emerge when a trend has to create new momentum before it can continue in its main direction. In these cases, the market creates a short-lived sideways movement or even a short trend in the opposite direction of the main trend.
The ability to recognize continuation patterns can save you from bad investments in supposed trends that in reality are continuation patterns. Since continuation patterns usually occur around half time of any trend, they can also give you a great indication for how long a trend will last. This enables you to invest in highly profitable touch options based on continuation patterns.
Technical indicators are a large group of indicators with many sub-groups. The one thing all technical indicators have in common is that they use market data to calculate a statement about the current market environment. The difference in technical indicators is which market data they use, how they calculate it, and how they display their result.
Moving averages are the most basic of all technical indicators. A moving average calculates the average price of the last periods and draws it into the chart. By repeating the process for all of the past candlesticks, they create a line. You can use this line as a resistance / support line, trade crossovers from two moving averages, or even the three moving average crossover technique.
Oscillators are indicators that are perfect for anticipating market movements. Oscillators are displayed in a separate window below your price chart. They calculate a value between 0 and 100. Whether the value is closer to 0 or 100 can allow you great insight into what is currently happening in the market.
While there are many different types of oscillators, most oscillators determine whether the market is currently overbought or oversold. As soon as the market enters either extreme, a turnaround in the opposite direction is highly likely. An even more significant signal is a divergence between the oscillator and the market.
Some oscillators also try to measure significant market data. Momentum indicators such as the average true range (ATR) try to measure how far the market has moved per period on average. This information can help you invest in touch and boundary options.
How can I use indicators for my trading?
To make money with binary options, you need to include indicators into your trading. While you can select the type of indicator you feel the most familiar with, there is no alternative to using some indicator. Without indicators, your trading would be random and doomed to lose you money.
So how can you use indicators for your trading? Well, there are two ways:
- You can use indicators to generate trading signals,
- You can use indicators to filter trading signals.
Let’s take a closer look at each of these two ways.
1. Use indicators to generate trading signals
Using indicators to generate trading signals is an essential part of every trading strategy. The first step to making money is finding a market situation in which you think that you can predict what will happen next. Indicators are the perfect tool to make this initial prediction.
Every indicator has a built-in prediction for what will happen next. Every candlestick allows for a concrete prediction about whether the market will rise or fall, every oscillator does the same, and every trend, too. By recognizing these patterns and understanding the predictions for which they allow you can generate trading signals and find profitable trading opportunities.
With a trend-based trading strategy, for example, you could generate signals by analyzing the current market trend.
- When the market is in an uptrend, you will invest in rising prices with a high option.
- When the market is in a downtrend, you will invest in falling prices with a low option.
- When the market is not trending, you will not invest.
In this way, indicators can easily generate trading signals that you can use to invest in a binary option.
To trade binary options, this could be the only way in which you use indicators. You create a signal; you invest – the process could not be simpler. There is, however, a good reason why you might want to think about using indicators to filter your signals, too. Let’s look at these reasons.
2. Use indicators to filter signals
Most binary options strategies filter the signals of their main indicators by adding other indicators. Such a strategy would create signals by using indicator A but only trade these signals if indicator B is showing the right reading, too.
Many traders of trends, for example, use oscillators such as the RSI to identify which trends they can still trust and which they should stay away from. Other traders combine moving averages with trends, only investing in trends that follow the general direction of the moving average.
Theoretically, there is no limit to how many indicators you can combine. By adding more indicators, many traders try to improve the quality of their signals and the profit that they make. This approach necessarily includes a tradeoff: adding more indicators to filter signals will create fewer trading signals, but, hopefully, signals of a better quality.
In this tradeoff, there is no right and wrong. Some traders like the risky approach and use their trading signals unfiltered. Some traders like to add indicators to create more secure signals. Depending on your personality, you should choose the approach that suits you best.
There is, however, a limit to the number of indicators you should combine. Using more than three indicators does little to improve the accuracy of your signals but makes it almost impossible to generate definitive signals. Consequently, we recommend never to combine more than three indicators in one strategy.
Another important thing to understand is that you can combine indicators of the same type. You can, for example, combine three moving averages that each use a different amount of time for their calculation.
What are the limitations of indicators?
When you use an indicator, it is important to understand the market environment in which this indicator works best and which market environment’s it is unfit for.
Moving averages, for example, are a great tool to find the right direction to invest in during trending markets. When the market is in an uptrend or a downtrend, you can count on your moving average to identify the right direction to invest in and when the trend is over. During sideways movements, however, moving averages are almost useless.
When the market moves up and down randomly or changes direction quickly and often, moving averages will start to mirror these quick, random changes in direction. They will switch from an upwards direction to a downwards direction and back often, and they will generate many false signals in the process.
These false signals can cost you a lot of money. When you invest during a sideways movement, your moving average trading signals are almost worthless – you might as well invest randomly.
The exact opposite of the moving average is the relative strength index (RSI). The RSI is ideal to determine when the market will turn around during a sideways movement, but during trends, it will create signals only rarely. It will tell you when a trend is over; but until then, it will be of limited help.
For traders, it is important to understand these limitations. In the simplest way, you can limit your indicators to trading environments in which they work well and stay away from everything else. Use moving averages only during trends and ignore sideways movements, and you will be fine.
Experienced traders that want to profit from every market movement can also adjust the indicators they use to the current market environment. When the market is in a trending environment, these traders will use moving averages, and when the market is in a sideways movement, they will switch to the relative strength indicator. This type of strategy can make money regardless of what the market is doing, but it requires a lot of experience.
Newcomers should master one indicator first before they work with the second indicator. It is better to do one thing well than to do two things half-heartedly.
Should I use leading and lagging indicators?
One of the major differences between indicators is whether they lead or lag market movements. Leading indicators try to anticipate new market movements before they start. Lagging indicators try to determine what has happened in the market recently.
The most important lagging indicator is the moving average. Because the moving average calculates the average price of past market movements, it always lags behind the market. When the market changes direction, it will take some time before the moving average reacts to this change and changes direction, too. Consequently, moving averages tell you what has happened in the market recently and whether the market has been moving upwards or downwards.
A major example for leading indicators is the RSI. The RSI tries to find weakening movements to predict a turnaround before the actual turnaround occurs. When the RSI predicts a change in direction, the market has often shown little to no sign of a turnaround, and without the RSI you would be unable to understand that something is wrong with the current movement.
When you combine indicators, it, therefore, makes sense to combine a leading indicator with a lagging indicator. The lagging indicator tells you what is happening, and the leading indicator tells you whether you can expect the market to continue into this direction. With this information, you know everything you need to make a quality investment decision.
Indicators are the only tool to predict market movements on short time frames. When you want to know whether an asset’s price will rise or fall over the next hour or so, only indicators can provide you with the necessary information to make this prediction. Fundamental market data is useless on short time frames because it ignores whether people are buying or selling an asset right now. Only technical indicators can help you understand the relationship between supply and demand that influences an asset’s price.
There are many different types of indicators, which makes it easy for traders to find an indicator they feel comfortable with. We recommend to try a few different indicators and decide which one works best for you.
You can use indicators to create trading signals or to filter the signals you created with another indicator. In this way, you can combine multiple indicators to increase the reliability of your signals.
Finally, you should consider the difference between lagging and leading indicators. Lagging indicators tell you what has happened recently in the market; leading indicators tell you what is likely to happen. By combining indicators of both types, you can create great strategies.
That’s it. With this information, you will be able to use indicators for your trading and create your own successful trading strategy.