Volatility indicators and binary options are a great combination. You can create a simple but highly profitable trading strategy. Even better: The two strategies we’ll teach you can help you win trades without having to predict which way the market will move. Trading couldn’t be simpler.

 

 

In this article you will learn:

  • What is a volatility indicator?
  • Why use volatility indicators for options
  • Three strategies for volatility

Using this information, you can create profitable binary options strategies based on volatility indicators.

What is a Volatility Indicator?

Volatility indicators are technical indicators. That is, it aggregates data from past market movements, applies formulas, and displays results in a way that traders can understand quickly and simply.

Technical indicators focus only on price action. That is, it ignores all basic information about the underlying asset, such as a company’s earnings or a country’s economic outlook. Instead, it analyzes what happened to an asset’s price in the past and makes a forecast based on this analysis.

A volatility indicator is a special type of technical indicator. Measures how far an asset deviates from its average directional value. It looks complicated, but it’s simple.

  • When an asset’s volatility is high, it moves away from the average direction. Earthquakes, for example, are highly volatile. Things have been quiet for a long time and now there is a strong movement changing direction. Highly volatile assets are subject to constant earthquakes. They often trade and reverse direction away from the moving average.
  • When an asset’s volatility is low, it has a strong sense of direction. For example, the Earth’s motion around the Sun has low variability. Low volatility assets share this strong sense of direction. Their direction may change over time, but they trade much closer to moving averages than assets that are more volatile and change direction much less.

A volatility indicator measures the volatility of an asset and displays it in an easily predictable way what will happen next.

Examples of volatility indicators

There are two main types of volatility indicators.

  1. An oscillator calculates a value and plots it as a separate chart, usually below a price chart. The relationship between present value and past value allows current traders to interpret what they are thinking now and predict what will happen next.
  2. Channels uses volatility to calculate price channels and plots these channels directly on the underlying chart. A channel surrounds the current market price and predicts the range in which the market is likely to hold. A channel that has moved too far from its average is likely to make traders nervous, which could lead them to invest in the opposite direction and bring the market back to the average.

Let’s look at examples of both types.

Example 1:  Average True Range (ATR)

There are many volatility oscillators. The most accurate is ATR (Average True Range). ATR tries to determine how far an asset’s average period has moved in the past, but uses a more accurate calculation method than other indicators.

Other indicators use fixed formulas. For example, always subtract the current period’s high value from the low value. This method is correct but ignores spacing. Sometimes the market moves from one price to another, creating a gap in the market. Momentum indicators that ignore these gaps paint a skewed picture. ATR’s main advantage is recognizing differences and factoring them into calculations.

Read our article on ATR for a detailed explanation of ATR. An important takeaway from this article is that ATR calculates the real range for each period and then creates an exponentially smoothed moving average.

The result tells you the average true range for the last period. For example, if the ATR has a value of 0.1, we know that the historical average period was £0.1. You can use this value to predict a range of future market movements.

Values can also be interpreted relative to previous values.

  • If the value has dropped from 0.2 pounds to 0.1 pounds, you know the market is losing energy.
  • If the value has risen from £0.05, you know the market is rising.

Both trends are likely to continue. They create different situations that call for different trading strategies, and ATR allows you to identify which one is right for you right now.

Example 2: Bollinger Bands

Bollinger Bands create a price channel around the current market price. The relationship between the market price and this price channel helps predict what will happen next.

The price channel of Bollinger Bands consists of three lines.

  • Moving average with midline. A typical value for this moving average is 20 periods. Theoretically, you can use any value you want, but this value works best for most traders. When the market is above the middle line, it acts as a support line. It acts as resistance when the market is below the midline.
  • Upper and lower lines based on standard deviation. Most traders use twice the standard deviation for both lines. The top line acts as resistance and the bottom line acts as support.

Bollinger Bands predict that the market will stay within the upper and lower bounds. The middle line triggers a barrier that can be either support or resistance. This means the market is likely to turn when it approaches the line. You might eventually break the middle line, but it’s very unlikely you’ll cross the outer line.

For traders, Bollinger Bands allow simple predictions. They provide a clear indication of possible ranges of movement and many resistance and support trade lines, making trading easy.

 

 

Why use volatility indicators for options

Binary options traders can benefit from volatility indicators more than traditional asset traders. There are two main reasons for this statement.

Some trades win by volatility alone

Traders in conventional assets cannot trade only on volatility. For example, stock traders may use a volatility indicator as a factor in their decision-making process, but the volatility indicator says little about whether an asset’s price will rise or fall, just predicting that it will go somewhere. do .

That’s unfortunate. Volatility indicators are one of the few types of indicators that can provide clear predictions, but they are insufficient to win trades for stock traders, making them unlikely to create simple, mathematical strategies.

But for binary options traders, just knowing that the market is going somewhere can help you win a trade.

Volatile and Boundary Options

Binary Options provides a tool called Boundary Options. Boundary options define two target prices above and below the current market price, at an equal distance from the current market price. As soon as the market hits one of these target prices, you get a binary option.

Boundary options are ideal for momentum indicators. For example, suppose an asset is trading at £100 and your broker offers a boundary option with an expiry period of 1 hour. Target prices are £100.20 and £99.80.

To predict if the market can reach your target price, simply apply the ATR and set the chart period to 1 hour. Two things can happen now.

  1. ATR reads above 0.2. In this case, we can see that the historical average period has moved over £0.20. Since this is enough for the market to reach the target price, you know you are likely to beat the boundary options
  2. ATR is less than 0.2. In this case, the averaging period would have been insufficient to earn a boundary option. If you have reason to believe that the next period will be stronger than average, you can invest anyway, but this trade would be a bad idea based on momentum indicators.

Depending on your tolerance for risk, you can adjust your strategy. You can wait to invest until the ATR reads two or three times as far as the two target prices. The longer you wait, the less chance you have of trading. But you will win a higher percentage of your trades, which is worth trading with risk averse traders.

Traders can triple their profits with volatility indicators

There are several types of binary options. There are often two or more similar types that differ only in the strength of the movement required. Types that require stronger moves reward traders by offering higher payouts.

For example, there are high/low options and ladder options.

  • High/low options allow you to predict whether the market will trade above or below the current market price when the option expires. If you’re right, you get about a 70-85% payout.
  • Boundary options allow the market to predict trades above or below a target price. If you expect the market to trade above your target price, well above the current market price, you can get payouts of up to 1,500%. If you expect the market to trade above your target price, which is below the current market price, you will only pay 20% or so.

The bigger the move, the better the payoff

Simply put, predicting stronger moves will result in higher payouts. The thing is, if you predict too strong a move, you will lose the trade and get no payout at all.

A momentum indicator like ATR is an ideal tool for predicting how strong a move will be.

For example, suppose your strategy predicts an upward movement for an asset trading at £100. If the ATR shows 0.2 on the 1-hour chart and the broker offers a ladder option with a target price of £100.10 and a payout of 150%, you know that you are likely to win the option. If you predict the upward movement correctly, you can win the option. Since the payout is twice as high as the high/low option, most traders will take the chance. If the ATR reads only 0.05, you should be trading high/low options.

In this simple way, momentum indicators will help you increase your average payout without changing your basic trading strategy. This gift cannot be passed on to serious traders.

Volatility Indicators Can Find New Trades

Binary options traders can also use volatility indicators to create trading signals. For example, when the market moves towards the Bollinger Bands, you know there is a chance the market will turn around. This is a prediction you can trade on.

Similarly, once the market breaks through the middle Bollinger Bands, you know that it is likely to continue moving until it reaches the outside of the Bollinger Bands. This knowledge gives a clear indication of how far the market will move.

Other technical indicators allow similar predictions.

Three strategies for volatility indicators

We have already seen three ways you can trade volatility indicators. Now you need to define a specific strategy you can trade on. Let’s take a closer look at how to trade binary options using volatility indicators.

Strategy 1: Combine Bollinger Bands and ATR

This strategy is very interesting in this article because it combines the advantages of the two momentum indicators we focus on. These advantages include:

  1. Bollinger Bands can predict how far the market will move.
  2. ATR can predict how long it will take to get to the market.

Both indicators combined provide enough information to trade binary options with high payouts.

Once the market breaks through the middle Bollinger Bands, it will move towards the outer Bollinger Bands. This prediction alone is sufficient to trade high/low options.

  • When the market breaks above the middle of the Bollinger Band, you invest in a high option.
  • When the market breaks below the middle Bollinger Band, you invest in lower options.

This strategy can make money, but the payout is limited to high or low options. ATR helps you make more money with the same strategy. Just compare the value of ATR to the distance of the next Bollinger Band.

trade example

Let’s see an example. Look at the hourly chart and assume that the next Bollinger Band is £0.1 away. The value of ATR is 0.025. Based on this knowledge, we can expect the market to advance to the next Bollinger Band in about 4 hours with a perfectly straight motion.

There is only one problem: no one can guarantee that all time periods will point in the same direction. If only one period points in the opposite direction, it will take longer for the market to reach the Bollinger Bands.

You can switch to a chart with a time period of 4 hours to confirm your forecast. For this example, assume an ATR of 0.075 on this chart. This means that the 4-hour average period is not enough to take the market to the next Bollinger Band. Expect it to take a little longer (probably around 5-6 hours).

Trading Volatility

This knowledge will help you trade binary options with higher payouts than high/low options.

  • If your broker offers you a one touch option with a target price at a distance of £0.05 and an expiry time of 4 hours, you know that you have a good chance of winning this option. This move is within the range of the Bollinger Bands and the ATR indicates that the market will move the required £0.05 within 4 hours.
  • The same calculation as in the first example applies if the broker offers a ladder option with a target of £0.05 off the current market price.

This strategy is simple and profitable. Bollinger Bands make generating signals easy, and ATR makes choosing an option type as simple as comparing a few numbers. You know the moves you can reach, and you simply choose the option type with the highest payout to make a profit on this move. The entire process is simple and easy. That is, the force of the momentum indicator.

Strategy 2: Trade ATR Readings Using Boundary Options

We have already covered this strategy. For traders who want to trade, we will now explain in detail. The process is simple and only requires comparing a few numbers. Here’s what you do.

  1. Create a price chart using ATR
  2. I set this price chart to a 5 minute time period.
  3. Now compare the reading of the ATR to the 5-minute boundary option offered by the broker. Two things can happen.
    1. The ATR reading is greater than the distance between the two target prices. Invest in this case.
    2. The ATR reading is less than the distance between the two target prices. Do not invest in this case.
  4. Repeat this process for all expirations offered by your broker. Match the length of the price chart period to the expiry period and invest when the reading of the ATR is greater than the distance to both target prices.

This strategy is simple. The only thing you need to figure out is if you want to discount ATR’s reading. For example, you might require that the reading of the ATR be twice the distance to the two target prices of the boundary option before investing. Try a few discount values and you’ll find the right strategy in no time.

Strategy 3: Trade Bollinger Bands and Non-Price Ladder Options

Ladder options can do more than create high payouts. They can also make very safe transactions.

  • If you expect the market to trade below your target price, well above the current market price, you are likely to win this option.
  • If you expect the market to trade above your target price, well below the current market price, this option will also win.

This strategy is simple and easy. However, there is a problem. Because they generate safe bets, these bets result in very low payouts. If you expect the market to trade below the highest payout when your ladder option expires, you can only get a payout of 10 to 20%.

Reduce risk with Bollinger Bands

With a low payout, you have to win a high percentage of trades to make money. You could lose money just by losing trades at the end of the week. So you need a tool that can avoid the rare situation where even safe predictions are lost. Bollinger Bands are an ideal technical indicator for this task.

If the price target falls outside the outer line of the Bollinger Bands, the market is very unlikely to reach it. You can always invest at a target price with the highest payout outside the Bollinger Bands to confirm your prediction.

Of course, the Bollinger Bands change with each new period. To use this in your trading strategy, you need to match the chart period to the binary options expiry. When thinking of trading ladder options with an expiry time of 1 hour, you should use the 1-hour chart and invest right at the start of the new period. The chart should be adjusted to leave enough time in the current period for the option to expire if 30 minutes have elapsed in the current period. For example, you can use 2 hours.

Trade volatility is not price

The beauty of this strategy is that it works without predicting the direction of the market. If the price falls outside the upper Bollinger Band, you get an option if the market goes down. You are also likely to win your options if the market is down. The same applies to prices outside the range of the lower Bollinger Bands.

To put this strategy into action, you only need to do three steps:

  1. Set the chart period to the shortest expiry period your broker offers for ladder options and apply Bollinger Bands to the chart.
  2. Compare your target price to the Bollinger Bands. Invest at a target price with the highest payout outside the range of the Bollinger Bands.
  3. Repeat the process for each expiry offered by your broker.

Additional Risk Management

You can also add a margin of safety. You can do this by requiring a specific distance where the target price is above the Bollinger limit.

If you apply this strategy correctly, you will find a 1 in 10 trading opportunity every day. You can check each chart whenever you create a new time period. For example, if your broker offers ladder options with expiry of 5 minutes, you can check the chart every 5 minutes. Even if only 50% of these checks give you a chance to trade, you’ll still find 6 opportunities every hour.

If your broker also offers ladder options with expiry 15, 30, 60, 120 and 240 minutes, you can also add this chart to your trading strategy. You can now find more trading opportunities.

In this way, this strategy will find many low-risk trading opportunities even if you only trade 2-3 hours each day. Your profit per trade is small, but you can make a lot of money based on many trades.

Conclusion

Volatility indicators and binary options are a great combination. Indicators such as Bollinger Bands and Average True Range (ATR) allow us to predict the range of movement and the direction in which the market will move.

You can combine both indicators to trade a highly profitable type of binary options, trade boundary options based on ATR, or trade ladder options using Bollinger Bands. Alternatively, you can add indicators to your strategy to avoid bad trades and increase payouts.

Volatility indicators offer hundreds of possible trading strategies. You can choose the one you like best, but it’s a good idea to at least add a volatility indicator to your strategy. Volatility is an important characteristic of any market environment and should be at least kept an eye on it.