Divergence in Binary Options Trading
For binary options trading, a divergence is a popular technical analysis tool which intermediate and advance traders use without knowing.
The Moving Average Convergence Divergence (MACD) Indicator is built upon divergence. Divergence is defined as two lines moving apart, usually moving average, extending out from a common center. In trading terms, when the given indicator show divergence, it is a sign of potential reversal and weakness in market.
Why Is Divergence Important for Trading?
In in the late 1970s, Gerald Appel in his book. The concept of divergence is clear, and people want to know why it is important for trading? Divergence is an indicator of potential reversal and weakness in the market. Divergences are simple and making buying options simple.
As you can see, the first peak in the series is strong and further makes a new high with high asset prices. In the MACD shown above, the next increase in asset prices met with another peak. This time it is a smaller peak. The next one will be further smaller. We can say that each time the market makes a new high, it is weaker than the last time. If the momentum is declining with each peak, it can finally lead to potential correction and exhausted market.
Divergence in Binary Options Trading
Traders must know that divergence is only a tool, and it’s not a signal. Although it is a useful measure of the market, traders must use it with other indicators to get signals. When divergence is applied to analysis correctly, it can help in predicting market reversals with a high measure of success. Remember, it doesn’t provide the signal when the reversal comes.
A market that is strongly trending can wind down for several months and years. The market will make new highs and lows while indicators diverge from the trend. As you can see in the chart above, each peak in MACD coincides with a peak in the asset’s price. You can’t ignore divergence because it is a powerful tool for market prediction when used with other indicators.
Divergence in Time Frames
Divergences in a time frame can help to time entries for binary options trading. You might see time frame divergence when prices are higher in the longer term and lower in the shorter term. Time frame divergence can also be when indicators in a longer time frame are pointing up, and the same indicators point down in a short time frame. If the short term trend is down and the long term trend is up, divergence can provide a good entry for a long term position.
Again look at the chart, and you can see a series of peaks and troughs. You can assume safely that a recent trough can result in another peak, so it is the ideal time to enter a bullish trade. Moreover, you can enter a trade with a one-month expiry and ensure that you have enough time to move to a shorter frame and look for a bullish signal. Bearish signals in the longer term would be divergent to bearish signal in a shorter term.
For practical explanation, look at the chart, as you can see in the mid or early October, there is a bearish peak of MACD. This strong bullish trend in the mid of October is an indicator that near term trend is reversing, and it could be the opening of the next long term rally. This bullish signal can result in lots of buying and numerous entry points for savvy traders.
How Divergence Show Reversals for Binary Options Trading?
It is mentioned at the start that divergence can indicate reversals. Although it is hard to pinpoint reversal because of the nature of divergence, it is possible. In rare cases, the divergence will wind down slowly and until the last peak is zero. Mostly there is some target known as a potential turning point. When asset prices meet the target along with divergence indicators, a reversal can occur any other time.
Divergence Binary Options Trading Strategy
This strategy is to look for when the indicator begins to show divergence from the price action. It has been seen that the price action will set its direction in the direction of divergence. The main thing is to identify convergence, and it is done by using the line tool. The line tool traces the high and lows of indicator and price. This strategy and indicator are used in binary options and forex. Trading binary options, there should be precision while making entries. Carefully observe the chart because of even a single pip matter.
A trader might get away by placing an incorrect entry in forex, but this improper entry can be proven to be costly in binary options. So, in divergence strategy, while trading binary options focus should be precision. Now the question is how to achieve precision? Don’t worry; there is a solution to every problem. You can use the line tool for tracing. The line tool can pinpoint divergence areas and also connect highs and lows. Moreover, it can trace trend lines to give the trader a sound base for resistance and support the entry.
This entry is usually made based on price rejection at the trend line and subsequent pullback by the entry candle. Now we have a signal candle, trend line, and entry candle to form the basis for precise trade entries.
An oscillator is the stochastic indicator and points out extreme price points and divergence signals. You can rely on this tool if you know how to apply a line tool for tracing divergence areas. You have to use the line tool correctly, and after doing this, you can easily trade with stochastic divergence opportunities.
Divergence in binary options trading is crucial and can indicate the bullish or bearish market. Moreover, by using the line tool correctly, you can predict the entry points and extreme price points. However, divergence is a useful tool, but it must be used with other indicators to get market signals.
Sky Hoon. Read Full Bio
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He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.