The Rainbow EMA
, better know as the Rainbow Exponential Moving Average
, is a binary options trading strategy that has become fairly popular amongst traders since it was first 'developed' and introduced few years ago. Although this strategy is indicator based it is not intended to produce High or Low signals, thus rather act as dynamic support & resistance during a trending market. With that being said it is important note that this trading strategy does require trending market conditions. Range bound markets are not favored when making use of the Rainbow EMA strategy. Although I am not a big fan of indicator based strategies I believe this can be used with success, if used the correct way. When used incorrectly it can lead to massive disappointment. So how do we use it the right way?
Moving Average Explained
In statistics, a moving average (rolling average or running average) is a calculation to analyze data points by creating a series of averages of different subsets of the full data set. It is also called a moving mean (MM) or rolling mean and is a type of finite impulse response filter. Variations include: simple, and cumulative, or weighted forms.
Sounds super complicated right? Well it does not have to be. Sometimes it is better to rather not over think things or even try to understand exactly how it works. The important part is that you know how to use it. And as you learn how to use it, you should get a better understanding of how it works.
Definition Of Exponential Moving Average
The Exponential Moving Average, also referred to as EMA, shares similar characteristics to the simple moving average (SMA) except that more 'weight' is given to the latest price changes. For this reason the Exponential Moving Average is also know as the 'exponentially weighted moving average'. This allows this type of moving average to react to recent price changes much faster than a simple moving average.
How To Add The Rainbow EMA
The Rainbow EMA consists of the:
- 6 Period Exponential Moving Average
- 14 Period Exponential Moving Average
- 26 Period Exponential Moving Average
It is important to make each EMA a different color, thus getting the name Rainbow EMA. Which color you make them is completely up to your personal preference, as long as they are easy to identify on your charts.
Figure 1 - 6, 14 and 26 EMA
Applying The Strategy To Binary Options
After adding all 3 exponential moving averages your charts should look something like the example below. To explain how this strategy is applied to binary options we will be using Figure 1 - Up Trending Market.
- 26 Period EMA
- 14 Period EMA
- 6 Period EMA
As you can see in the case of a uptrend we expect to see the 26 EMA (bottom - red) followed by the 14 EMA (middle - green) and lastly the 6 EMA (top - purple). The opposite is true when looking at an downtrend. It is critical that the EMA's are lined up in those orders according to the trend direction. The 14 Period EMA will always be in the middle, acting as our trigger line. We would thus wait for price to touch our trigger line (14 Period EMA) before placing either a call or a put trade. The more the lines are spread out in the correct order the better of a trading signal we can expect. This will occur when we have a strong trending market in either direction, and is thus the ideal time to use this strategy. The Rainbow EMA strategy can be used on almost any inraday(M1, M5, M15, M30, H1) time frame.
Metatrader indicator for Rainbow EMA
As always, MetaBinaryOptions is offering you a free Metatrader
indicator for helping you apply this strategy.
Click here to download the indicator 100% free
The indicator will automatically draw 35 EMA.
Figure 2 - Metatrader Indicator for Rainbow EMA
Rainbow EMA Summary
As you can see this strategy is arguably one of the easiest and most basic, yet it can be very effective in the right market conditions. Once again it is important to note that there is no guarantee that price will bounce of our trigger line every single time. Although it does act as dynamic support or resistance price can easily violate it and cause a change in trend. Always use confluence and be on the lookout for these turning points in the market.