Learning how to combine option trading and technical analysis is a great way to maximize your profits on the stock market.

Magic indicators do NOT exist

The use of technical analysis in trading is a somewhat controversial topic as it has been proven many times that it is extremely difficult to accurately time the market over a long time.

There are no magic indicators out there that are going to be able to give you perfect buy and sell signals consistently, but this does not mean there is no merit behind studying the chart of a stock.

There is a wide range of different technical indicators such as moving averages, volume profile, fibonacci retracements, pivot points, and much more.

Technical analysis can provide context

To become a successful options trader, you are not required to learn any of this, but technical indicators can be a great way to provide context to what is happening in the market.

If you were to just simply look at a candle chart of two different stocks with no indicators, it can be difficult to determine how the market is pricing these stocks.

Keep it simple

With the use of a common indicator such as the 200-day moving average plotted on each chart you can see the context and trend each stock is in.

Let’s say you notice a stock index like the Nasdaq is trading below its 200-day moving average, and an oil ETF is trading above its 200-day moving average.

You can conclude that stocks are not doing as well as oil is which provides that context.

Common Indicators

● Moving Averages

There are two types of moving averages, one of which is a simple moving average (SMA) and the other is the exponential moving average (EMA).

Both require a length input which determines how far back in time the indicator covers. One of the most common SMA’s used is the 200 SMA on a daily timeframe.

When a 200 SMA line is plotted on a daily chart (each candle represents one day) this is also known as the 200-day moving average.

When a stock is trading above this 200-day moving average it is considered to be in an uptrend while if it is trading below this line the stock is generally considered to be down trending.

● Volume Profile

The volume profile is not as well-known as other indicators, but it is a very useful one to use.

Normally we can view the amount of volume traded on a stock per day as a vertical bar. This is great but it does not tell us what price the most volume was occurring at.

Volume profile will show you volume by price and is plotted horizontally on the chart.

You will notice that at certain prices there is a lot more volume occurring than others.

This price is known as a high volume area or an area of value. It is the price in which shares have traded hands most times, so it is viewed as an area of value to both the buyers and the sellers.

From this information, we can gather that these high-value areas are where most people’s cost basis will be whether they are short or long.

The price of a stock generally tends to revert to these points of value often, so people often try to fade the extremes of the value area.

For example, when the price falls below the high volume area to another area with a lower amount of volume, they will buy here to fade the shorts and attempt to ride the shares back up to the area of value. This is just one strategy and there are many nuances involved with this indicator.

Bottom Line

Using technical indicators should come second to developing an options strategy that is expected to have a positive expectancy in the long run.

It can be very useful to find areas of value and determine that one price might be a better spot to buy than another, but without a strategy to manage your risk and take profits, this can become useless information.

What I mean by this is that support levels are only valid until they are broken and you are left with an unrealized loss. One way to combine technical analysis with an options strategy is to go long at areas of support and set a stop loss below this area in case it breaks.

If you put the risk to reward in your favor each time and have a strategy of where to cut losses and take profits, then technical analysis can be an amazing tool to improve your win rate and profitability.