What Are Some Best Technical Indicators For Options Trading?
There are lots of technical indicators that traders can use depending on the type of security and trading style. Technical indicators can play a crucial role in predicting the future prices of the stocks.
For stock analysis, a combination of technical indicators and charts is used. In this article, you will find out some of the better technical indicators for options trading.
How Technical Indicators Help Options Traders?
Technical indicators can be used for short-term trading. Technical indicators help traders to determine the following things:
- The direction of the move
- Range of movement
- Duration of the move
The problem with options is time decay. So holding periods of options becomes crucial. An options trader is restricted by time duration because options have expiration dates. While a stock trader can hold a position for an unlimited time.
Best Technical Indicators for Options Trading
Some common and frequently used technical indicators are given below:
It is a momentum indicator and used to make a comparison between the magnitude of recent profits and losses over a specific time period. It is used to determine the change in price movement and security’s speed.
The value of RSI ranges from 0-100, and the value that is over 70 is used to indicate overbought levels. The value below 30 is used to indicate oversold levels. RSI can be useful for individual stock options.
Options traders know the importance of volatility in options trading. For measuring volatility, Bollinger bands are used. When the volatility decreases, these bands contract, and in case of an increase in volatility bands expand. When the price is closer to the upper band, it means the security is more overbought, and when the price is closer to the lower band, it is the indicator that security is oversold.
When the price is outside the bands, it means security can reverse, and traders can make adjustments to their positions. In case of a breakout above the top band, traders can use a short call position or long put. When the breakout is below the lower band, traders have the opportunity to use a short put strategy or a long call position. In general, it is better to sell options during the periods of high volatility when prices are high, and buy option during low volatility options because prices of options are low.
When the option traders are looking to bet on intraday moves, the IMI indicator is the best choice for high frequency. The concepts of RSI and Intraday are mixed, so they provide a suitable range. This range is similar to RSI and indicates the oversold and overbought levels for intraday trading. IMI can help options traders to spot opportunities to initiate a bearish or bullish trade when prices are high and low, respectively.
Formula to calculate IMI is the sum of up days divided by the sum of up days plus the sum of down days, such as (IS up divided by IS up+ IS Down), and then it is multiplied by 100. Traders choose the timeframe, and mostly 14 days are chosen by traders. It is similar to RSI, and a number above 70 indicates the overbought stock and below 30 indicates the oversold stock.
MA is used to identify the direction of price trends. It is not affected by the interference of short-term price spikes. A single trend line is presented by combining price points of a financial instrument and then dividing them by a number of data points.
Data used for calculation depends on the length of MA. MA can help to check previous price action and history of price. In other words, MA can be used to predict future price patterns.
MFI is a momentum indicator, and it works by combining the data of volume and price. In other words, it can be considered as volume-weighted RSI. MFI is used to indicate the inflow and outflow of the money over a specific timeframe (usually 14 days).
MFI is an indicator of “trading pressure.” MFI value ranges from 0-100, value over 80 shows that security is overbought, and a reading below 20 indicates that security is oversold.
MFI depends heavily on volume data, so it is a good option for stock-based trading instead of index-based. It is good for longer-duration trades. When MFI moves in the opposite direction to the stock price, it means it is indicting a trend change.
PCR measures the trading volume by using put options versus call options. Changes in PCR value indicate a change in overall market sentiment.
When puts are more than calls, it means the ratio is above 1, and it is a symbol of bearishness. When the calls are more than puts, the PCR ratio is less than 1, and it indicates bullishness. However, traders see PCR as a contrarian indicator.
OI indicates unsettled contracts in options. It is different from other technical indicators and doesn’t indicate a specific uptrend or downtrend. It only indicates the strength of the trend.
When OI increases, it indicates the inflow of the new capital and the strength of the existing trend. When OI decreases, it indicates the outflow of capital and weakening trend.
Tip: Trading With Multiple Indicators
If you are trading with one technical indicator, you can’t become rich because each indicator has some limitations. To make your trades profitable, the best thing you can do is use multiple indicators at a time. You can use indicators in pairs to get the best results.
The above-mentioned technical indicators are some of the best indicators used by options traders. These are only a few because there are hundreds of technical indicators. Other technical indicators that can be used for trading options are (Cumulative Tick, Average True Range, stochastic oscillators).
An options trader should choose the indicator based on the trading style and security. As there are too many technical indicators but the most used indicators are RSI and Bollinger Bands.
Sky Hoon. Read Full Bio
Website Owner, Twitter-er
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.