Digital Options are commonly known as binary options. As the terms suggest, these options have two distinct outcomes during the time of expiration, either in-the-money or out-of-the-money, with respect to the strike price. Despite its simplicity, successful traders know that before getting into any trade, they must do their homework. They must analyze the market to understand its behavior. Just like traditional trading instruments, digital option traders rely on good analyses to help identify price trends, price targets, buy signals and sell signals. There are two main ways to analyze the market, through fundamental analysis and through technical analysis. Both methods may be used independently or in conjunction with the other to help gain market insight.
Technical Analysis
Technical Analysis involves the study of past price movements of a security and compiling the data in statistical forms to help predict future price moves. Although technical analysis has its basis in mathematics, it must contend with the fact that most trades are controlled by humans who don't necessarily behave in logical fashion. Some of the methodologies used in technical analysis, both objective and subjective, include means reversion, tracking momentum or moving averages, trend following, and pattern recognition.
Extend- Extend (Roll Over) enables traders to extend the time of expiration in order to increase their odds of being in-the-money. For example, if a trader purchased an option that is not performing as they expected, they can extend the time of expiration and give themselves the opportunity to be in-the-money by paying a flat one time fee.
Principles of Technical Analysis
Technical Analysis is the quantitative study of prices and volumes in order to predict the price of an underlying asset like a stock, currency pair, index or commodity. This type of analysis helps traders determine what is likely to happen in the future so that they can make accurate market moves and high returns on their investments.
Applying Trend Following Techniques to Digital Options
Trend following is a form of technical analysis that looks at historical data on to see if a trend is occurring. A trend is most simply defined as any sustained movement in one direction. By looking at the historical moving average of an asset, one can determine whether or not a trend is developing. Here is a trading example:
You are interested in purchasing gold, and want to see if there is an established trend. You look at the 2-day moving average for Gold, as well as the 5-day moving average for Gold. If the 2-day moving average has crossed significantly either above or below the 5-day moving average, you can safely assume that a trend has developed, in either an upwards or downwards direction.
Means Reversion
The concept behind means reversion is that assets tend to settle back towards their mean. If a trader can determine the mean of an asset, it will make it much easier to predict the direction accurately and get the high return on the investment.
Tracking Momentum to Trade Digital Options
Tracking momentum is a common tool used in technical analysis. By using the moving average convergence-divergence (MACD) indicator, an investor can determine whether the momentum of an asset is rising or falling, and place their trade accordingly. Calculating momentum is a complex affair, but once an MACD indicator is determined, it can be used to track the changes day to day of short-term and long-term averages. If the short-term averages are generally larger than the long-term averages, momentum can be said to be increasing, while if they are smaller, momentum can be said to be decreasing.
Pattern Return
Finally, many technical analysts look for patterns in the movement of an asset or sector of the market. Finding these patterns can be somewhat complicated, and false patterns may lead a trader to invest unwisely, but if properly used pattern recognition can lead to long-term profitability.