TRADING BINARY OPTIONS WITH RSI INDICATOR - STRATEGIES AND HINTS
RSI or the Relative Strenght Index is one of the most popular indicators to analyze a market. Before anything, it is an oscillator, meaning it will appear in a separate window, typically at the bottom of a chart. The idea of an oscillator is to compare its movement with the one the price makes. On top of it, the oscillator shows a move’s strength or weakness.
Therefore, a trader’s job is to interpret the market based on what the oscillator does. For binary options trading, it means buying call or put options. A standard period offered by most of the trading platforms is the 14 one. Effectively, it means the RSI will consider fourteen candles before plotting a value.
Of course, we can edit it. However, do that only if you understand the implications. The bigger the period, the flatter the line becomes, and the RSI losses its purpose.
Overbought and Oversold Levels with the RSI
The RSI travels only in positive territory. More precisely, it goes between zero and one hundred. However, those are extreme levels. Virtually, as a trader, you don’t have any chance to see them coming.
Even the most potent moves caused by fundamental news would barely see the RSI breaking the 80 level. As such, it is no wonder that the standard interpretation of the RSI is to pay attention when the price hits the 30 and 70 levels.
As a rule of thumb, the 70 level shows overbought territory, and binary options traders will look to buy put options. On the other hand, a move below the 30 represents the oversold area, offering the possibility of purchasing call options.
The problem with this approach comes from a simple fact: everyone knows that. And, if that would be true in one hundred percent of the cases, everyone would make money. However, we know that’s not the case. Therefore, it must be something wrong with this approach, right?
The answer is somewhere in between. Overbought and oversold levels do work! But, they work when the market moves in ranges. Hence, the key to trading binary options with the RSI indicator’s overbought and oversold areas is to identify a range.
Trade the Asian Session
One way to identify a range is to look at the Asian session. Typically, the prices range during this session. Of course, it depends very much on the underlying security, but currency pairs range in Asia. As such, using overbought and oversold areas might bear some fruits.
Merely buy call options when the RSI hits the 30 level and put options when the 70 comes. It works like a charm during the Asian session. Anyways, it works most of the times. Pay attention, though, to the start of the European session as such a strategy will fail moving forward.
Trade Before Important Economic Events
Traders don’t like to take chances ahead of significant economic events. No one wants to take unnecessary risks. Therefore, the market will most likely range until the news comes out. The perfect example is when the NFP (Non-Farm Payrolls) is due.
Every first Friday of the month, the U.S. jobs data is released. Because of its importance, the market tends to range until Friday’s release. As such, using overbought and oversold levels would work with excellent results. However, there’s a catch: keep the expiration date shorter than the moment the NFP comes out.
In any case, as long as traders identify a range, overbought and oversold levels work. But, when the market starts trending, it’ll stay in the overbought and oversold territory for quite some time. Hence, traders must adapt.
Fortunately, the RSI can spot trend reversals too. Find out how in the second part dedicated to this beautiful indicator.
If on the first part, we looked at how to trade ranges with the RSI, what can we do when the market trends? Is there another way to use it? The thing is that any oscillator, not only the RSI, has been conceived with the following idea in mind: to spot fake moves. If traders know a move is potentially false, they’ll use the information to take a position in the opposite direction.
Plus, there’s one more thing. The current price always shows the movement of the present candle, whereas the RSI or any oscillator, plots the value considering many candles. Therefore, if we are to trust some of the two lines, we should believe the oscillator.
Divergences with the RSI
A divergence represents a different move than the one the price makes. Typically, the RSI just won’t confirm the price’s movement. The key to understanding a divergence is to look at the way the price moves. And, compare it with what the RSI shows.
In a bullish market, the market advances making a series of consecutive higher highs. If this is what the RSI shows too, the two are correlated. However, if the RSI doesn’t confirm the new higher high, a bearish divergence forms. Binary options traders will buy put options on such a divergence.
A bullish divergence appears when the RSI doesn’t confirm the last lower low in a bearish trend. Therefore, traders will buy call options. A divergence is more potent if it appears in the overbought or oversold territory. More precisely, when both higher highs form above the 70, the divergence is more powerful than if the second one would be below.
The same is true when a bullish divergence forms with both lower lows below the 30 level. When it forms, the price has more significant chances to jump. As always, trading is not that easy. Binary options traders must correlate the expiration date with the time frame the divergence appears on.
Moreover, in sharp trends, the market may stay in a divergent mode more than a trader can remain solvent. As such, traders use different approaches. If you come to think of it, with a divergence, traders trade the potential trend reversal. In trading, that’s the riskier approach ever. Aggressive traders love it, but conservative traders won’t take the trade. They’ll wait for the trend to reverse, and then trade trend continuation patterns in the new direction.
If a divergence doesn’t form in the overbought or oversold areas, it doesn’t mean the price won’t reverse. However, it is wise to ignore it, as it may be just a consolidation before the original trend resumes.
The two videos dedicated to how to trade binary options with the RSI indicator show plenty of examples for both range trading and trend trading. Despite its simplicity, the RSI gives excellent results if used in concordance with a sound money management plan.
When trading, the tools used won’t matter. What’s important is to trade with a plan in mind, and therefore the money management is more important than technical or fundamental analysis.
