Mean Reversion in Technical Analysis for Binary Options
Mean reversion involves identifying an asset’s mean and then determining if the asset price is settling back to that point. It is rather like testing a rubber band to see how far it will stretch before it snaps back.
Analysts employ technical indicators such as Bollinger Bands to measure mean reversion. Bollinger Bands employ various statistical factors, such as supply management, in order to generate a set of bands to contain the price action. Bollinger bands allow any trader to instantly view price on a chart relative to its volatility mean over a period of time.
Volatility is the rate at which the price of a currency pair moves up and down in the market. When high volatility can be seen, the upper and lower Bollinger bands widen and when the price fluctuations decrease, the bands contract. The price usually bounces off the range whenever it touches the upper or lower band.
A second group of technical indicators that are used to measure mean reversion are Relative Strength and Stochastic indicators. Both of these technical indicators measure how fast a market has moved in the short term, relative to movements over a longer period.
Stochastic indicators, in particular, are based on the principal that in an up trending market, stocks tend to close near their highs and in a downward market stocks tend to close near their lows. These indicators create an index that is used by traders to determine if a market is overbought or oversold.
In general, technical indicators are successful because of their popularity among traders, which is based on the reasoning that “volume generates movement”. The logic follows that the more investors who are trading in a certain direction, the more that direction is set to continue.
By utilizing these indicators, a trader is essentially trading in the same direction as many others. This insight can be useful when trading short term. To improve the chances of accumulating consistent profits from binary options trading, there are two types of analysis that traders can employ: technical analysis and fundamental analysis.
Fundamental analysis looks at how outside influences can affect asset prices; technical analysis focuses on how a price has moved in the past and how that can determine future movements. Both types of analysis are essential tools for traders.
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More important information regarding this topic:
- » Support and Resistance in Technical Analysis for Binary Options
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- » Introduction to Technical Analysis for Binary Options
- » Momentum in Technical Analysis for Binary Options
- » Pattern Recognition in Technical Analysis for Binary Options