Moving Averages. Part 1: basic concepts and classical variants
- VFX Blog
- For beginners
Financial traders are increasingly relying on computers, fast communication channels and mathematical algorithms. Beginners before thinking how to make money on binary option should remember that – «all-new is well overlooked old», and use of the Moving Average (MA) continues to bring stable profits to the next generation of traders.
The moving average indicator is one “oldest” technical analysis tools used by stock traders before computers appeared in manual mode. Now it is in all popular trading platforms. It is considered one of the best trend determinants for all trading assets (currencies, stocks, futures, options).
Calculation and basic Moving Average
Moving Average smooth’s out market "noise" to see the global direction of the current trend. The indicator chart can be used as a dynamic support/resistance level. The calculation uses the sum of the prices of a trading asset for a given historical period, for example, 14 days, followed by division by their number. As a result, for each moment, there is an arithmetic mean of past price fluctuations without “noise”.
The calculation can be made at Open/Close or High/Low prices. In the terminals, you can find other options such as the Median Price. But they are not widely used, for most strategy Close price used.
The reliability of binary options signals is determined by the number of estimated periods, not just by switching to higher timeframes. The more of them, the more important is the change of direction or the break out of the MA. For example, 200-period shows a medium-term trend when they break through, usually a full trend reversal, or the current movement will continue shortly.
The figure shows a Simple Moving Average with a classical algorithm at different prices.
There is no significant difference in the direction of movement in the same period.
The basic condition of the MA analysis: is that if the price is above the average, there is an uptrend, if below - a downtrend. When moving sideways, the line runs parallel to the price and additional channel indicators are needed to confirm the opening of trades. They can also be built based on Moving Average.
In addition to SMA, the following variants of the indicator are popular, which are considered standard and present in most binary trading platforms:
• Exponential (EMA). Unlike the simple one, which does not distinguish between calculated price bars (periods) implying them to be equally significant, EMA considers the latest data to be more important. From the closing of the current price, the significance decreases exponentially from the first most sensitive bar to the last calculated one, which practically does not affect the determination of the trend.
The EMA algorithm allows you to react faster to market changes to trade more efficiently on small (up to H1) timeframes. Most scalping and intraday strategies for how to make money on binary options apply it is the exponential moving average. With the increase in periods, the sensitivity drops when it reaches more than 100, there is no significant difference compared to SMA
Linear Weighted (LWMA, WMA). Modification of the EMA moving average with a different algorithm assigning significance (weights) periods. Also, the last bar has the greatest weight, then the significance decreases more sharply in relation to exponential. Reacts even more too sharp price changes, so more is used in the stock market, where trends are initially more smoothed as opposed to volatile Forex. There is a binary options strategy where, in addition to the amount of the period, the weights are adjusted.
• Smoothed (SMMA). Inverse algorithm: the most past periods have more weight, which then decreases successively to the current bar. Thus, the movement of the smoothed chart becomes more resistant to small price fluctuations without increasing the number of periods. It is rarely used and never as the main element for making trading decisions.
Before we continue to study Moving Average, let's pay attention to such an important parameter as lagging the reaction of the moving average relative to the current market. Technical analysis operates only with historical data, so there will always be a lag, but in this case, it significantly affects the result. This is due to the smoothing algorithm itself, you can only try to minimize it, but it is impossible to get rid of it completely. Always confirm the indicator data with other tools, such as oscillators!
Moving average on binary options
Each strategy or indicator has its settings, but there are general principles of how binary options signals work using MA on all financial assets:
Find the optimal MA period for a trading asset.
The main rule is to reduce the moving average calculation period when we increase the timeframe. This removes the extra smoothness that is needed at small intervals to skip the "noise" and is not needed on charts from H1 and above. In addition, on short periods statistics are better on EMA, on older ones it is better not to waste time on experiments and stop on simple SMA.
Each asset requires periods that take into account its features and current volatility, but as a starting point you can recommend the following combinations for binary signals:
• 34-55-144 for M1-M15 timeframes;
• 8-34-55-89-144 on H1 (hour) ;
• 8-13-21-55-89 for D1 (day);
• 8-13-21 for weekly and above.
Binary options guide is considered significant periods of 100 and 200. They point to long-term trends; their breaking is a signal to a possible complete change of trend. You should also pay attention to their retests, in which case you need to be ready to close the current positions.
Moving Average can be applied not only to the price chart but to the indicator data, as an additional element for oscillators and worked out according to the standard method.
Angle moving average.
The main purpose of the indicator is to show the balance of power between sellers and buyers. If the averages are directed upwards, the buyers outweigh and uptrend, otherwise the sellers dominate. The horizontal direction confirms the temporary truce. Even when a trend is determined correctly, there will be a problem of assessing its strength, because the prospects of the opened deal depend on it. Perhaps it is only a short-term impulse or correction. Visually, this can be determined by the angle of line relative to the previous movement.
The greater the angle of inclination, the stronger the potential for rising or falling quotes. At small angles, binary options for newbie’s recommend skipping the signal even if there is additional confirmation in the form of overbought/oversold. Which angle works on a particular asset can only be determined empirically, but as a method of binary options for newbie’s that quickly evaluates the market, it is reliable, especially on higher timeframes.
Trade by crossing Moving Average.
Binary options open only at the intersection points of the moving average with other MAs or price levels: significant Highs/Lows, Fibonacci and others. There is only one rule - breakdown from the bottom-up means a possible purchase, top-down from a sale. A simple reversal and the beginning of movement indicate only a change in trend, not a quick opening of the position!
The moving average can trade for breakdown and rebound, especially from “long” (100, 200) periods. In this case, you should use methods for determining the true breakdown, a trailing stop will help to improve the result, allowing you to completely "pick the trend" to the end and close the option without loss at the beginning of the correction.
In the second part of the article, read how to increase the reliability of binary options signal from moving averages and recommendations for use.