Volatility indicators and binary options are a great combination. It can create simple but very profitable trading strategies. What’s even better: two of the strategies we teach you can win you a trade without requiring you to predict the direction the market will move – trading couldn’t be simpler.

 

 

In this article you will learn:

  • What are volatility indicators?
  • Why use volatility indicators for options?
  • Three strategies for volatility

With this information you will be able to create your own profitable strategy for binary options based on volatility indicators.

What are volatility indicators?

Volatility indicators are technical indicators. This means that they gather the data from past movements, apply a formula and display the result in a way that allows traders to quickly and simply understand what is going on and what will happen next.

Technical indicators focus solely on price action. This means that they ignore all fundamental information about the underlying asset, for example the earnings of a company or the economic outlook of a country. Instead, they analyze what has happened to an asset price in the past and create forecasts based on this analysis.

Volatility indicators are a special form of technical indicators. It measures how far an asset deviates from the average directional value. It might sound complicated, but it’s simple:

  • If an asset has high volatility, it deviates far from its average direction. An earthquake, for example, has high volatility. Things have been quiet for a long time, and now there is a strong movement that often changes direction. Assets with high volatility have constant earthquakes. They often trade far from their moving averages and frequently change direction.
  • If an asset has low volatility, it has a strong sense of direction. For example, the earth’s movement around the sun has a low variability. Low volatility assets share this strong sense of direction. Their direction can change over time, but they trade much closer to their moving averages than assets with higher volatility and change direction much less.

Volatility indicators measure the volatility of an asset and display it in a way that makes it easy to predict what will happen next.

Examples of volatility indicators

There are two main types of volatility indicators:

  1. Oscillators calculate a value and plot it in a separate chart, usually below the price chart. The current value and its relationship to past values allow for interpretations of what traders are currently thinking and predictions about what will happen next.
  2. Channels use the volatility to calculate a price channel and draw this channel directly in your main chart. The channel surrounds the current market price and predicts the range in which the market is likely to stay. Channels predict that the market that has moved too far from an average is likely to make traders nervous, leading them to invest in the opposite direction and bring the market back to its average.

Let’s look at examples of both types:

Example 1: The Average True Range (ATR)

There are many volatile oscillators. The most accurate of these is the average true range (ATR). The ATR seeks to find out how far an average period of an asset has moved in the past, but it uses a more accurate calculation method than other indicators.

Other indicators use a fixed formula, for example, always subtract the current period from the lowest. Although this method is accurate, it ignores gaps. Sometimes the market jumps from price to price, creating a gap in the market. Momentum indicators that ignore these gaps paint a distorted picture. The biggest advantage of the ATR is that it recognizes gaps and takes them into account.

Read our article on the ATR for a detailed breakdown of the ATR. For this article, the important point is that the ATR calculates each period’s true range and then creates an exponentially smooth moving average.

The result tells you the average true range of the last periods. For example, if the ATR has a value of 0.1, you know that an average period has had £0.1 in the past. You can use this value to predict the range of future market movements.

You can also interpret the value in relation to previous values.

  • If the value has dropped from £0.2 to £0.1, you know the market is losing energy.
  • If the value has risen by £0.05, you know the market is picking up steam.

Both trends are likely to continue. This creates different situations that require different trading strategies, and the ATR helps you identify which one is 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 you predict what will happen next.

The Bollinger Bands price channel consists of three rules:

  • A moving average as the center line. The typical value for this moving average is 20 periods. Theoretically, you can use any value you want, but this value has worked best for most traders. If the market is above the median, it acts as a support line. If the market is below the center line, it acts as a resistance.
  • An upper and lower line based on the standard deviations. Most traders use a value of twice the standard deviation for both lines. The upper line acts as resistance, the lower line as support.

Bollinger Bands predict that the market will stay within the upper and lower line. The center line acts as a barrier that can be a support or a resistance. This means that when the market approaches a line, it is likely to reverse. Although it may eventually break the center line, it is very unlikely to move beyond the outer lines.

For traders, Bollinger Bands allow simple predictions. It gives clear indications for the possible reach of a move and many resistance and support lines that enable easy trades.

Why use volatility indicators for options?

Binary options traders can profit more from volatility indicators than traders with conventional assets. There are two main reasons for this statement:

Some trades win on volatility alone

Conventional asset traders cannot trade volatility alone. For example, stock traders may use volatility indicators as one factor in the decision-making process, but volatility indicators say little about whether the price of an asset will rise or fall—they only predict that it will go somewhere.

It is unfortunate. Volatility indicators are one of the few types of indicators that can provide clear predictions, but they are insufficient to win stock traders a trade, robbing them of the possibility of creating a simple, mathematical strategy.

For binary options traders, knowing that the market is going somewhere can be enough to win a trade.

Volatility and Frontier Options

Binary options offer a tool called limit options. A limit option defines two strike prices equidistant from the current market price, one above the current market price and one below it. If the market reaches one of these strike prices, you immediately win your binary option.

Border options are ideal for momentum indicators. For example, assume an asset is trading at £100 and your broker offers you a limit option with an expiry of one hour. The target prices are £100.20 and £99.80.

To predict whether the market can reach one of the target prices, you only need to apply the ATR and set the period of your chart to one hour. Now two things can happen:

  1. The ATR reads 0.2 or more. In this case, you know that an average period has moved £0.20 or more in the past. Since it is sufficient for the market to reach the strike price, you know that there is a good chance that you will win the limit option
  2. The ATR reads less than 0.2. In this case, you know that an averaging period would have been insufficient to win your limit option. If you have reason to believe that the next period will be stronger than average, you can invest anyway, but this trade will be a bad idea based on the momentum indicator.

Depending on your tolerance for risk, you can adjust your strategy. You can wait to invest until the ATR reads two or three times the distance to both target prices. The longer you wait, the fewer trading opportunities you will find. But you win a higher percentage of your trades, which can be the price of value for risk-free traders.

Traders can triple profits with volatility indicators

There are many types of binary options. There are often two or more similar types that differ only in the strength of the movement required. The type that requires a stronger move compensates traders by giving a higher payout.

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

  • High / low options allow you to predict whether the market will trade higher or lower than the current market price when the option expires. If you’re right, you’ll get a payout of around 70 to 85 percent.
  • Limit options allow you to predict whether the market will trade higher or lower than a strike price. If you predict that the market will trade higher than a strike price that is well above the current market price, you can get a payout of up to 1,500 percent. If you predict that the market will trade above a strike price below the current market price, you will receive a lower payout, perhaps as little as 20 percent.

Greater movement means greater payout potential

Simply put, if you predict a stronger move, you will get a higher payout. The problem is, if you predict too strong a move, you lose your trade and don’t get paid out at all.

Momentum indicators such as the ATR are the ideal tool for predicting how strongly you should forecast.

For example, assume your strategy predicts an upward move for an asset trading at £100. If the ATR reads 0.2 for an hourly chart, and your broker offers you a learning option with a strike price of £100.10 and a payout of 150 percent, you know that there is a good chance that you will win the option. If you correctly predicted an upward movement, you will probably win your option. Since the payout is twice as high as with a high/low option, most traders will take the chance. If the ATR would only read 0.05, you should trade a high/low option.

In this simple way, momentum indicators can help you increase your average payout without having to change your basic trading strategy. For serious traders, this gift is impossible to pass up.

Volatility indicators can find new trades

Binary options traders can also use volatility indicators to create trading signals. For example, if the market moves towards a Bollinger Band, you know that it is likely to reverse. This is a prediction that you can trade.

Similarly, if the market has broken through the middle Bollinger Band, you know that it is likely to continue until it reaches the outer Bollinger Band. This knowledge gives a clear indication of how far the market will move, which can also be a prediction.

Other technical indicators allow for similar predictions.

Three strategies for volatility indicators

We have tackled all three ways you can trade volatility indicators. Now we need to define concrete strategies that you can trade with. Let’s see how you can trade binary options with volatility indicators.

Strategy 1: the combination of Bollinger Bands with the ATR

This strategy is so interesting for this article because it combines the benefits of the two momentum indicators we have focused on. These benefits are:

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

Together, both indicators provide you with enough information to trade a high-payout binary option.

If the market has broken through the middle Bollinger Band, it will likely move to the outer Bollinger Band. This prediction alone is enough to trade a high/low option.

  • If the market has broken through the middle Bollinger Band in the upward direction, you invest in a high option.
  • If the market has broken through the middle Bollinger Band in the downward direction, you invest in a low option.

This strategy can make you money, but it limits your payouts to high/low options. The ATR can help you earn more money with the same strategy. All you need to do is compare the value of the ATR with the distance of the next Bollinger Band.

Trade example

Let’s look at an example. Assume you are looking at an hourly chart and the next Bollinger Band is £0.1 away. The ATR has a value of 0.025. With this knowledge, you can predict that a straight move will take the market to the next Bollinger Band after about 4 hours.

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

To check your forecast, you can switch to a map with a 4-hour period. In our example, let’s assume that the ATR reads 0.075 in this chart. This means that an averaging period of 4 hours would be insufficient to take the market to the next Bollinger Band. You should expect this to take a little more time, probably around five to six hours.

Volatility trades

This knowledge helps you trade a binary option with a higher payout than a high/low option.

  • If your broker offers you a one-push option with a strike price in the range of £0.05 and an expiry of four hours, you know that you have a high chance of winning this option. The move is within reach of the Bollinger Bands, and the ATR indicates that the market will move the required £0.05 in less than four hours.
  • If your broker offers you a learning option with a strike price of £0.05 away from the current market price, the same calculation as in our first example applies.

This strategy is simple and profitable. Bollinger Bands help you create signals easily; the ATR makes choosing the right option type as simple as comparing a few numbers. You know what moves are within reach, and all you have to do is choose the type of options with the highest payout to take advantage of this move. The whole process is simple and easy – that’s the power of momentum indicators.

Strategy 2: Trade the reading of the ATR with limit options

We have already touched on this strategy. For traders who want to implement this, we will now explain it in full. The process is simple and requires you to compare only a few numbers. Here’s what you do:

  1. You create a price chart with the ATR.
  2. You set this price card to a period of 5 minutes.
  3. Now you compare the reading of the ATR with the limit option that your broker is offering you for a five minute expiration. Two things can happen:
    1. The ATR’s reading is greater than the distance to both target prices. In this case, invest u.
    2. The reading of the ATR is smaller than the distance to both target prices. In this case you do not invest.
  4. You repeat this process for each expiration your broker offers you. Match the length of the period of your price chart to the length of the expiration, and if the reading of the ATR is greater than the distance to both target prices, invest.

This strategy is simple. The only thing you need to figure out is if you want to discount the reading of the ATR. For example, you can require the reading of the ATR to be twice the distance to both target prices of your limit option before investing. Try a few discount values, and you will soon find the right strategy for you.

 

 

Strategy 3: Trading Ladder Options Based on Bollinger Bands and Out-of-Range Prices

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

  • If you predict that the market will trade below a strike price that is well above the current market price, you are likely to win this option.
  • If you predict that the market will trade above a strike price that is well below the current market price, you are likely to win this option as well.

This strategy is simple and easy, but there is a catch. Because it creates safe predictions, these predictions get you a very low payout. If you predict that the market will trade below the highest payout when your learning option expires, you may only get a 10 or 20 percent payout.

Reduce Risk with Bollinger Bands

Low payouts require you to win a high percentage of your trades to earn money. Just a few losing trades can be enough to lose money at the end of the week. Therefore, you need a tool that can help you avoid the rare situation where you would lose even a safe prediction. Bollinger Bands is the ideal technical indicator for this job.

If a strike price lies outside the outlines of the Bollinger Bands, the market is unlikely to reach it. To check your prediction, you can always invest in the strike price with the highest payout outside the Bollinger Bands.

Of course, Bollinger Bands change with each new period. To be able to use it for your trading strategy, you must match the period of your card with the expiration of your binary option. If you are thinking about trading a learning option with a one-hour expiration, you should use a one-hour chart and invest right when a new period starts. If 30 minutes have passed in the current period, you must adjust your card to allow enough time in the current period for your option to expire. For example, you can use a period of two hours.

Volatility in trade not prices

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

To execute this strategy, you only need to follow the three steps:

  1. Set the period of your chart to the shortest expiration your broker offers for a learning option and apply Bollinger Bands to the chart.
  2. Compare the strike prices with the Bollinger Bands. Invest in the strike price with the highest payout outside the range of the Bollinger Bands.
  3. Repeat the process for each expiration your broker offers.

Further risk management

You may also consider adding a safety margin. You can do this by requiring strike prices to be a certain distance outside the Bollinger limits.

With the correct application, this strategy can find tens of trading opportunities every day. You can check each chart every time it creates a new period. For example, if your broker offers ladder options with an expiration of five minutes, you can check the chart every five minutes. If only 50 percent of these checks give you a trading opportunity, you will still find six opportunities every hour.

If your broker also offers learning options with an expiration of 15, 30, 60, 120 and 240 minutes, you can also add these charts to your trading strategy. Now you can find even more trading opportunities.

In this way, this strategy can find you many low-risk trading opportunities, even if you only trade for two or three hours each day. Your profit per trade will be small, but on so many trades you can still make a lot of money.

Closing

Volatility indicators and binary options are a great combination. Indicators such as Bollinger Bands and the ATR (Average True Range) help you predict the magnitude of a move and the direction in which the market is likely to move.

You can combine both indicators to trade highly profitable types of binary options, trade options on the border based on the ATR alone, or use Bollinger Bands to trade ladder options. Alternatively, you can also add one of the indicators to your strategy to avoid bad trades and achieve a higher payout.

Volatility indicators offer hundreds of possible strategies for trading. You can choose the one you like best, but you should at least consider adding volatility indicators to your strategy. Volatility is an important characteristic of every market environment, and you should at least keep an eye on it.