Two key concepts to get to grips with when trading with binary options are those of Support and Resistance levels. They are perhaps two of the most basic elements of technical analysis and it is vital that you have a good understanding of them.
They are easily incorporated into your existing trading and you will find that most strategies will make use of them to identify points to place stop or profit levels. In short they are a very powerful tool.
Understanding Support And Resistance
The terms ‘support’ and ‘resistance’ refer to levels in the market that have previously stalled price gains or falls. Essentially they identify points at which sellers of an asset are prepared to enter the market (in the case of support) or liquidate their gains (in the case of resistance).
Here’s a brief definition: -
- A support level sits under the current price. It is therefore often referred to as the price ‘floor.’
- A resistance level sits above the current price. It is therefore considered to be the price ‘ceiling’.
Take a look at the image below. It shows a daily chart of the EUR/USD. A number of support and resistance levels have been plotted across the chart. These can be interpreted as the expected points at which buyers and sellers will enter the market when these price levels near.
Note also how these levels can also be formed from rising and falling trends in the price. The moving averages also provide support and resistance to price movement both when the price is rising and falling.
A further important point to note about support and resistance is the way that these levels change when the price moves through them. Once a levels of resistance is breached by the price it then becomes a new level of support. Similarly once a support level is breached it will then provide resistance to subsequent gains in price.
There are a number of ways in which support and resistance levels can be identified. It would be wrong to assume that they are some unique and mystical level. Common support and resistance levels can be previous highs and lows, rising channel levels, retracement levels or pivot points.
These levels can often be easily identified by taking a look at the price chart and visually noting where price movements have previously stalled or bounced. When looking for these levels it is important to note that support and resistance levels that exist in higher chart time-frames such as on the daily or weekly charts, are going to be stronger than those from say, a 5 or 15 minute chart. Also consider that if a level has been tested and held many times previously, then it is likely that it will take a considerably strong impetus to breach when the price nears it again.
Another place where support an resistance occurs is at psychological price levels. All time highs and lows or new ‘trading ranges’ can also reject price moves. For example, when the price first approaches a new high a temporary sell off may be triggered, with price high being seen as resistance to further gains. Often a significant change in fundamental market outlook is required for a price to push and sustain gains into this new range.
While support and resistance levels are an important trading concept, they should be considered complementary to a strategy, rather than the basis of a complete trading strategy for binary options in themselves.
Having said that, you could form a really simple trading approach based on placing a contract to profit from the expected price rejection whenever a support or resistance level is neared. This could be a suitable way in which to profit from price rejections near strong support/resistance near all time highs or lows.
A better approach to using these technical levels would however be to combine them with the use of a technical indicator. For example you would mark key levels on a chart and then look for overbought/oversold readings on a technical indicator such as the RSI to form a overbought or oversold binary options trading strategy.
Things To Consider
While these levels are invaluable for the trader, don’t make the mistake of putting all of your faith in them. Support and resistance levels are not permanent and therefore you need to expect the price to push through them at some point
As mentioned previously, the general theory is that the more times that a level has been tested, the stronger it will be. Therefore it is worth noting the levels which exist on high time-frame charts (daily, weekly) even if you are trading at low time-frames. Levels set at these higher levels will be stronger and therefore less likely to fail.
An important point to consider when trading binary options with support and resistance is that they are only approximate levels. Often an enthusiastic market can see an asset price temporarily extend beyond a level. Therefore be prepared to give each level that you identify a measure of tolerance. Depending on the market that you are trading, 5-10 price ticks either side of the identified level would be a good starting point.
Like much of technical analysis there is no concrete reason why support and resistance levels should work. An explanation could be that they are self-filling. With so much attention placed on these levels by traders it is conceivable that the sheer volume of orders which are situated at these points can cause the anticipated reaction to happen.
No matter how or whey these work, you should have a good grasp of them if i you want to improve your binary options trading.