Trading Options Using Technical Analysis

There are two basic ways of picking stock options to trade, technical analysis and fundamental analysis (if you don’t count hot tips, gambling and playing your hunches). Both have their merits. In my opinion a combination of the two is probably the best approach. This article focuses on technical analysis. Fundamental analysis will come later.

Technical analysis focuses most of its attention on price movements.  Little attention is given to the issue of “why” a given movement is occurring.  A purely technical trader does not care “why” a particular movement is taking place, only that he is on the correct side of the market.

Likewise, unlike a fundamental trader who needs to track specific cause and effect factors for various markets, to many technical analysts, a market is a market and the same tools often used across the board.

Technical analysis can take any number of forms.  Typically, it involves the use of price charts.  Patterns and trends are analyzed to see if clues can be discerned regarding the next likely movement in price.  Technical analysis can also often involve the use of indicators and oscillators, all of which are designed to tell a trader when the time might be right to buy or sell.

Many traders will utilize trend lines in an effort to trader only in the direction of the predominant trend.  As long as soybean prices held under the declining trendline, these traders would only look to establish short positions in soybeans.

Conversely, once prices broke above that trendline and a new rising trendline could be drawn, these traders would only look to trade soybean from the long side.  An old adage in trading is “the trend is your friend”.  This is one example of a way to identify the dominant trend in a given market.

An indicator such as MACD (moving average convergence divergence) is very useful.  In addition, a chart formation known as a double bottom is highlighted on the price chart.  Some traders look for patterns, such as a double bottom or double top to form and then use a directional indicator that can then be used to forecast when to enter into a new position.

In this example, after the double bottom formed, a trader might take a buy signal from the MACD indicator as a trigger to enter a long position in coffee futures.

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Option Trading Secrets