In the last post we introduced the envelope indicator. This is a not too complex indicator, which is based on the idea of mean reversion, i.e. how the Bollinger bands assume the fluctuation of the prices around an average, to which the price should return over and over again.
The envelopes each represent the outer bands, which can either be
- as resistance and support in an existing trend or
- are defined as breakout zones.
We have also indicated that in the case of (2) it is always necessary to distinguish whether the breakout creates a new momentum in the direction of the existing trend or whether the price is overstressed and a dynamic snapback is likely. This can be done either by simple market setups or by additional indicators. In the next step, we will develop a strategy for short-term trading with the envelopes indicator.
Short-term trading with the envelopes indicator
In our strategy with the envelopes, we concentrate on trading the S&P 500 Index that unites the 500 most important US stocks.
This index is much broader than, for example, the leading German index DAX with a total of only 30 stocks.
Because we want to act according to market technology we are less interested in the compilation. For this we set up the following pre-rules:
- We trade on the 15-minute chart.
- Both call and put options are bought.
- The running time is one hour.
After we have defined the general rules, we start with the analysis and the rules for the signals. We have to define when a signal for the purchase of a call and when a signal for the purchase of a put option arises. In principle, the rules are the same, but each point in the other direction.
Since we decided to trade within the bands, it is clear that we will use the bands as resistance and support. So the first rule for us is that a buy signal could arise if the price was on one of the bands. This will not be uncommon because the bands are lagging indicators, so they are following the course.
Next, it will be important to recognize whether this resistance or support is really relevant. Since courses are always zigzagged, it would not make sense to buy every time the course is on the line. You have to filter out the really good opportunities. We do this with the help of relevant price zones and the RSI indicator.
The technical zones and the RSI indicator show us whether the trend is still constant or whether it is already weakening.
The upper chart something looks confusing for the S&P 500 Index. However, trading signals would only have occurred in the circled areas; the first of them right at the beginning of the visible trend. We have a rising RSI indicator as well as a rebound of the course on the lower band of the envelope indicator. The runtime of one hour would have been enough to bring the option "in the money". It is clear below why the signal rules are important.
Although the price bounced off the upper band several times, buying the option without observing the RSI indicator would have led to losses because the RSI indicator showed a trend continue to increase strength. The rebound of the course all lasted less than an hour, so that our running time would have turned against us in the end.
The first notable rebound (second circle) would have taken place later. This did not lead to a major countermovement, but to a sideways phase; however, this lasted longer than an hour, so that it would have been enough for an "in the money" expiring option. Even after that, the RSI indicator showed increasing strength, so that the rebound on the upper band would not be well suited for counter-positioning.
The next weakness was also clearly visible with the help of the RSI indicator (third circle). Since the course never rebounded on the assembly line, there was no signal - even if the RSI indicator showed strength. However, what we do see is a possible turnaround in the trend: the prospect of a possible trading signal could soon emerge.
Conclusion - Envelopes as a zone indicator
As you could clearly see, the Envelopes indicator are almost never used alone. This is mainly due to the fact that it is very lagging. It should be seen for what it is: an indicator that indicates relevant zones. How these zones are subsequently interpreted depends on the selection of the other parameters. In summary, we used the following rules for our short-term strategy and only received three reliable signals, which are however sufficient for this period:
- We are trading on the 15-minute chart.
- Both call and put options are bought.
- The term is one hour.
- Buy signal is issued if the RSI weakness (positions against the trend) or strength (for positions with the trend) and the price is on one of the bands.
With the broker anyoption, traders can implement such short-term strategies well.
Other interesting articles by the same author:
- Binary Options Strategy Guide
- Binary Options One Touch Trading
- Dax Trading Binary Options
- Binary Options Regulation