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Technical analysis is the science (or art!) of studying charts of market prices and using historical data to attempt to determine where the market is likely to move next. In this piece we will take a look at some popular forms of technical analysis that can be applied to binary options markets in order to turn a profit.
The trend is your friend
Trend following is a time honoured and proven technical analysis strategy popular in the forex and stock markets. Traditional ‘buy and hold’ trend following strategies can’t be applied to binary options due to the short term, binary nature of the contracts, but binary traders can still gain a significant edge by trading in the direction of the trend.
The first step is to identify the direction of the trend:
- An up, or ‘bull’ trend, is characterized by a series of higher lows and higher highs
- A down, or ‘bear’ trend is characterized by a series of lower lows and lower highs
Once you have identified the trend, the aim is to look for trading opportunities in the direction of the trend. In a bull trend you will be looking for buying, or ‘Higher’ opportunities, and in a bear trend you will be looking for selling, or ‘Lower’ opportunities. You could look to trade a breakout, or continuation of the trend, or another option is waiting for a resumption of the trend after a structural correction.
Candlestick charts were developed centuries ago in Japan and came to dominate western charts in the mid 20th century. Candlestick charts are far superior to a simple line chart as they show you all the information you need to analyze a particular market: the high, low, open and close (line charts only display the closing price). Candlesticks aren’t just a great way of displaying market data though, a savvy binary options trader can use what’s known as candlestick patterns to predict markets.
A candlestick pattern is a distinctive candlestick, or series of candlesticks, that usually leads to a reversal or continuation of the market trend. Reversal patterns are likely the more popular of the two as they help the trader adhere to the age-old adage of ‘buy low and sell high’. There are far too many candlestick patterns to list here but we will name a few of the more popular ones that all traders should familiarize themselves with:
- Bullish Engulfing – A bullish reversal candle that occurs at the end of a downtrend, closing above the open of the final bearish candle.
- Bearish Engulfing – A bearish reversal candle that occurs at the end of an uptrend, closing below the open of the final bullish candle.
- Bullish Hammer – A bullish reversal candle that occurs at the end of a downtrend. A new low is set initially, but the candle eventually closes slightly above or below the open, leaving a small body and long lower wick that resembles an upright hammer.
- Shooting Star – A bearish reversal candle that occurs at the end of an uptrend. A new high is set initially, but the candle eventually closes slightly above or below the open, leaving a small body and long upper wick.
Candlestick patterns are extremely popular amongst Originoption traders as they can be very reliable for predicting the next market move.
Chart patterns are another popular method of technical analysis used by Originoption traders. Where a candlestick pattern is usually only comprised of 1-3 candles, a chart pattern is comprised of a multitude of different candles, which together, form a larger pattern. Just like candlestick patterns, chart patterns are very reliable and can signal both trend reversal and continuation.
The most widely recognized and reliable reversal pattern is the Head and Shoulders bearish reversal pattern. This pattern appears at the end of an uptrend and is characterized by a series of three highs, with the middle being the largest, vaguely resembling a human’s head and shoulders. The trader enters short on a break below the ‘neckline’, the line connecting the two shoulders.
Another related pattern is the Inverse Head and Shoulders, which is the same pattern but flipped upside down and which occurs at the end of a down trend. Once again, the trade signal occurs on a break above the neckline.
If you’d like to know more about candlestick and chart patterns, be sure to check out Bulkowski’s thepatternsite.com which has pictures and performance statistics for each and every chart and candle pattern.
This was just a quick introduction to technical analysis in binary options, as you can see there are many different approaches which suit different people and different strategies. It’s also worth noting that these approaches aren’t necessarily used in isolation and are often welded together by the most successful traders. Want to get started? Come over to Originoption today and hone your analysis and trading skills on a free demo account!