There are hundreds of technical indicators, as traders, we can use depending on our trading style and the type of security to trade. Here, we will discuss a few important technical indicators popular among option traders. We can better understand them with Live Technical Charts.
How Options Trading is Different
Technical indicators are often use for short-term trading to help the trader determine:
Range of movement (how much?)
Direction of the move (which way?)
Duration of the move (how long?)
Since options more often subject to time decay, the holding period comes into significance. A stock trader or investor can hold a position indefinitely, while an options trader is constrain to limited period and allow upto the option’s date of expiration.
Given the time constraints, momentum indicators like MACD, RSI, etc., which will give you the overbought and oversold levels, that are popular among option traders.
Let’s see some of the common indicators — momentum and others – option traders frequently use them.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) is a momentum indicator which gives the magnitude of recent gains to recent losses over a particular period of time to guage a security’s speed and change of price movements to determine overbought and oversold conditions.
RSI values range from 0 to 100, with a value above 70 is usually taken to indicate overbought condition, and a value below 30 to oversold condition.
RSI is consider one of the best technical indicators for options on individual stocks, unlike indexes, as stocks specify overbought and oversold conditions more often than indexes.
Options trading for high-liquid, high-beta stocks make the best choices for short-term trading based on RSI.
All option traders should know the importance of volatility and Bollinger bands are one of the best way to measure volatility. The Bollinger Bands expand as volatility increases and contract as volatility decreases. If the price moves closer to the upper band, it signifies overbought condition of the security, and if the price moves closer to the lower band, it signifies the more oversold condition.
A price move outside of the bands can signal the security is well-trade for a reversal, and option traders can take positions accordingly. For example, after a breakout above the top band, the trader may take a long put or a short call position. Conversely, a breakout below the lower band may show you an opportunity to use a long call or short put strategy.
Always bear in mind that it usually makes sense to sell options at times of high volatility, when option prices are higher, and buy options at times of low volatility, when option prices are cheaper.
Money Flow Index (MFI)
The Money Flow Index is a momentum indicator and it combines price and volume data. It is known as volume-weighted RSI. The MFI indicator specifies the inflow and outflow of money into a security over a period (usually 14 days), and is an indicator of “trading pressure.”
A level above 80 indicates that a security is overbought, while a it’s value below 20 indicates that the security is oversold.
Because of it’s dependency on volume data, MFI is believed to suit to stock-based options trading (than index-based) and longer-duration trades. When we see that if the MFI moves in the opposite direction as the stock price, this will be a leading indicator of a change of trend.
Put-Call Ratio (PCR) Indicator
The put-call ratio indicates volume of trade in put options versus call options. Instead of absolute value of the put-call ratio, when any changes occur in its value, that means there is a change in overall market sentiment.
If there are more puts than calls, the ratio is above 1, signifying bearishness. And if call volume is higher than put volume, the ratio is less than 1, signifying bullishness.
However, traders also consider the put-call ratio as a contrarian indicator.
Open Interest (OI)
Open interest tells the open or unsettled contracts in options at any particular time. OI does not necessarily specify any uptrend or downtrend, but it does show signals about the strength of a specific trend.
Increasing open interest means new capital inflow and, hence, sustainability of the current trend, while declining OI means a weakening trend.
General perception for option traders to benefit from short-term price changes and trends, note the following:
Market/security is strong
Market/security is weakening
Market/security is weak
Market/security is strengthening
Tips for Successful Trading…
Besides the above-stated technical indicators, there are dozens of other indicators that can be used for trading options (like MACD, stochastic oscillators and ADX ). It’s always advisable to use combination of two or more indicators for a successful trading.
Every trader is choosy about his or her favorable Top Technical Indicators for Options Trading and stock trading which best suits him or her – follow them, master them and be a successful trader and investor.
All the traders and investors need a PIVOT POINT CALCULATOR to know the next support and resistance levels while trading and also FIBONACCI CALCULATOR to assess the probable next price points to trade either in downtrend or uptrend.