Those familiar with some of the basic elements of technical price analysis have probably used candlestick charts in some of their market analysis and this is generally because these charts make it very easy to make broad assessments with a quick glance. But one under-utilized aspect of these charts can be seen in the candle formations, which can give strong indications of how prices are likely to move in the future.
This can be highly valuable information for binary options trades, as candlestick patterns can give a great deal of information when forecasting price direction. This is critical for knowing when a trader should enter into a CALL or a PUT, so here we will look at some of the ways candlesticks are interpreted and at some of the most commonly used patterns so that these signals can be used in trading.
Interpreting the Charts
Candlestick charts are highly valuable for spotting reversals in trends and entry/exit points for new trades. But how can we interpret the information given by these charts? First we must understand the anatomy of the candle.
Candlesticks are comprised of information explaining the High, Low, Open and Close for the given time period. The high is shown at the upper end of the top shadow, while the low is seen at the end of the bottom shadow. The body shows the difference between the open and close of the period, and different colors will be used depending on whether or not the opening price was higher than the closing price. This can be seen in the graphics below:
Next, we look at the candlestick chart as a whole to see how these candles fit into the larger picture:
Long Bodies and Short Bodies
Looking at the size of the candle body can also give traders important information about potential price direction. Short candle bodies indicate restricted price movement and consolidation. Conversely, longer bodies suggest stronger buying and selling pressure. Long wicks attached to these bodies suggest higher levels of volatility.
The Hanging Man and Hammer Patterns
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Now that we understand how to interpret these charts, we will now look at ways to spot potential reversals in price (which is key for constructing binary options trade ideas). The most common patterns in this category are the Hammer and Hanging Man patterns, and we can see examples in the graphics below:
When prices are showing a strong downtrend, traders can look for bullish trading opportunities once a Hammer formation becomes apparent. The logic behind this approach comes from the fact that prices are already at extreme lows but markets have snapped back (evidenced by the long lower Hammer wick). This pattern marks a potential turning point and a good opportunity to enter into new CALL positions for the asset.
Conversely, when prices are showing a strong uptrend, traders can look for bearish trading opportunities once a Hanging Man formation becomes apparent. The logic behind this approach comes from the fact that prices are already at extreme highs (too expensive) but markets have failed after reaching these heights (evidenced by the long upper wick). This pattern marks a potential turning point and a good opportunity to enter into new PUT positions for the asset.
The next candlestick reversal patterns we will look at are the Engulfing patterns (bullish and bearish). These are shown in the graphic below:
Bearish Engulfing patterns often become apparent when prices are showing a strong uptrend, and bearish trading opportunities can be taken on the expectation of a downside reversal. The logic behind this approach comes from the fact that the previously bullish sentiment is now being “overshadowed” by bearish momentum, and prices are likely to continue lower. When these patterns are seen, traders can enter into PUT options based on these expectations.
Bullish Engulfing patterns often become apparent when prices are showing a strong downtrend, and bullish trading opportunities can be taken on the expectation of a upside reversal. The logic behind this approach comes from the fact that the previously bearish sentiment is overextended and is being overcome by bullish momentum. Since prices are likely to continue to move higher, traders can look to establish CALL options when these patterns become apparent.
Using Candle Stick Patterns to Spot Price Reversals
From the examples above, we can see that chart candlestick patterns can provide an easy way to determine potential reversals in prices. This information can be critical when looking to establish a trading bias using binary options. When prices are showing a strong downtrend, a bullish reversal candle can help to create solid opportunities for CALL options. When prices are showing a strong uptrend, a bearish reversal pattern can be a good indication that the rally is over and that traders should consider PUT options.