Technical analysis of options trading charts is the standard way of predicting market movement for the purpose of opening and closing positions. Like any other form of prediction, technical analysis does not always provide the correct answer. Learning the skill through study and developing experience by paper trading and years of real market trading use during different market conditions improves a trader's prediction performance.
Moving Averages and MACD
Some of the most accurate and -- therefore -- most popular technical indicators are moving averages. These may be simple 5-day, 20-day and 200-day moving averages or they may be weighted in some way using a mathematical formula like that which creates the moving average convergence divergence indicator. A good indicator of options market direction is when the shorter-term moving average crosses the longer one, either up or down. That nearly always indicates a tradeable trend.
Relative Strength and Stochastics
Charts graphically depict support and resistance levels, which are also an extremely useful indicator. They represent the volume of options trades at certain price points. This is important because when the market unexpectedly declines, people tend to get so nervous they wait while the price declines to a support bottom and sell their positions when the price trades back up to reach their original buy-in price. They want to at least break even and are afraid the price will again drop. This creates resistance in an up market. Support in a down market occurs when people buy back into a trade when the price reaches a point at which they had previously bought. The greater the volume of options held at these critical price points, the greater the resistance or support. Resistance and support tend to disappear as the pent-up buying and selling interest is satisfied by trades at those prices. The relative strength index measures this pent-up interest and stochastics is based on a mathematical formula that modifies the RSI, presumably to create a more accurate predictive tool.
Trading Ranges and Bollinger Bands
If enough people buy at the support point, the option price will bounce up from its downswing. If enough people sell at the resistance point, the option price will drop. This price behavior indicates a trading range between the support and resistance points. Trend lines drawn to connect the trading tops and other trend lines drawn to connect trading bottoms define a trading range. Bollinger bands also show trading ranges, with the inclusion of math to factor in price volatility. Bollinger bands are normally drawn using the 20-day simple moving average and its standard deviations. When the bands are far apart, the option price is more volatile. Volatility is good for short-term trading or day trading and risky for longer-term holds. Markets tend to be volatile at highs and lows, which mark the end of trends.
Many technical analysts use advances and retracements to time their options purchases and sales. The most popular measure of these market movements is the Fibonacci number series. After 0 and 1, each number in the series is the sum of the two prior numbers. Fibonacci numbers are thought to be a good representation of a natural progression, so are considered a good predictor of the percentage movements of market prices. Market movements, after all, are merely the result of human action and reaction. Many filters have been applied to the Fibonacci number series, and it is recognized as having validity in analyzing market movements to predict ultimate lows and highs.
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