Options Trading Indicators
When you trade stock options there are two types of options trading indicators. These are fundamentals that eventually determine the prices of stocks and technical analysis indicators that help assess short term market sentiment and short term price fluctuations. When you watch our videos you will see that one of our commonly used strategies is to spot a bump up in the market by using a bear call spread to profit when the market settles back to its previous level or even below. Likewise, when we spot what we believe to be a momentary drop in the market we commonly use a bull spread to profit from the rebound.
Video: Discover the OODA Loop (Observe, Orient, Decide, and Act)
Moving Averages
A moving average is a way to even out the ups and downs of the stock market and to profit when stocks are going too high or too low. Traders commonly use options trading indicators like the 50 day moving average to decide when stock that tends to cycle up and down has run its upward or downward course. While the eventual price of a stock is determined by profits, the market is always trying to predict what is coming next. Thus, stock and options traders are constantly trying to anticipate price action and that is done with indicators. For example, you have head us refer to the space between the fifty day and two hundred day moving averages on a stock chart as no man’s land, similar to the space between the trenches in World War I. This is because traders do not believe that the stock price will remain in this region and are thus constantly trading in ways that will drive the price out of this zone.
Relative Strength Index
The relative strength index (RSI) is an indicator that helps you get into the minds of other traders. It compares the strength of recent gains and losses over specific time frames. By measuring the speed and changes of price movements it helps a trader determine if a stock or a stock option is overbought or oversold. It uses a 0 to 100 chart on which 70 is overbought and 30 is oversold. Traders use this indicator for individual stocks more so than for indexes and for very short term situations. A trader may believe that fundamentals will drive a stock price higher or lower and will then use the RSI to confirm their suspicion before entering a trade.
Bollinger Bands
Volatility creates opportunities for trading individual stocks and for market-wide indexes such as the S&P 500. Bollinger bands are a useful indicator of volatility. These “bands” expand with higher volatility and contract as volatility diminishes. Within the bands, price movement toward the upper band indicates an overbought situation and movement toward the lower band indicates an oversold situation. And, when prices move outside of the bands this indicates the likelihood of a reversal. A good rule of thumb with Bollinger bands is that when volatility is high it is often better to sell options and when volatility is low it is a better idea to purchase options as they are typically cheaper at these times.
Money Flow Index
There are times when the market is driven as much by how much money is available for investment and trading as by fundamentals and technical factors. The money flow index measures volume and price data. It measures how much money is flowing into or out of an asset over a given time period. Fourteen days is the usual setting for this. It is considered a “trading pressure” indicator where a score of 80 or more tells you that the security is overbought and a score of 20 or less indicates that it is oversold. This indicator is better used for specific stock options than for index-based options or for long-term options like LEAPs.
