Trading Binary Options with CandlesticksUsing CandleStick Analysis for Options
Candlestick indicators are one of the most utilised tools in a trader’s chest.
They allow the trader to form a view on how the option is likely to expire, up or down. When it comes to Binary Options, when the expiry time is set to the timeframe examined with the Candlesticks, trading becomes that much more profitable. If you are slightly unfamiliar with the technicalities, you can read our refresher on Binary Option Basics.
If you are considering trading Binary Options with Candlesticks, then our candlestick strategies below are your best starting point.
What are Candlesticks?
Japanese Candlesticks (or just CandleSticks) are a graphical representation of key levels within a defined time period. These are the open, close, high and low. They are particularly helpful for traders who want to get an idea of volatility in a particular range.
From the image on the right, you can see that there is quite a bit of information that you can gather from the CandleStick. The candlesticks also differ in color and can either be green (white) and black (red).
Taking a look at the image, there are a number of characteristics of each candle. The difference between the open and the close is termed the “body” of the candle. If the candle closed higher (close above open) then the body is green. The opposite can be said for the candle that closes lower with the red body.
The short lines that are above and below the candle represent the range which the price traded throughout the period and are the difference between the high / low and the open / close levels.
When trading binary options with candlesticks, the trader tries to identify unique individual candles as well as formations of a range of different candles.
In general, large green candles are bullish indicators and large red ones are bearish. This is based on the principle of momentum in trading.
However, the binary options trader will not only examine the individual candle but will take a look at candlestick formations.
Before the binary options trader can use a number of different strategies with CandleSticks, he has to become aware of the various formations that apply to candle sticks. These give a lot of information about where the asset is going and hence how the next candle will perform.
Formations are usually a collection of more than two candles. They are usually also used in conjunction with other technical indicators such as trends, volume and other trading signals. What is also important to note is that the formations can be viewed over any time period from a minute up to a number of days. When trading binary options with candlesticks, formations are an essential part to any strategy We will look at some of the most well known CandleStick formations.
When a candlestick formation is engulfing, the one candle is completely “engulfed” by the proceeding candlestick. The candle is usually engulfed by a candle that is a different color than the original candle.
When a small red candle is engulfed by a much larger green candle then this is a bullish engulfing candle. This is given on the left of the image. On the other hand, a Bearish engulfing pattern occurs when a small green candle is completely engulfed by a large red candle. This is on the right of the image.
Taking a look at the Bullish engulfing pattern, this indicates that the price has attempted to move down but has found some support and buying volume. Depending where it is on the trend, it could either be an indication of a continuation or a reversal.
The opposite can be said for the Bearish Engulfing Candle. It is an indication that either an uptrend is about to reverse or the downtrend is likely to continue.
Morning and Evening Stars
Morning / Evening stars are usually only presented in times of market illiquidity and hence “gapping” in the price. This is usually at times like overnight or over the weekend.
In the image, the morning star is on the left. The way that the trader can interpret the morning star is that initially, the sellers are in control of the market. However, the second candle gives a slight indication of a reversal to a bullish trend. Indeed, the large green candle confirms this.
The evening star has the same explanation. Initially, the buyers are in control. However, it appears as if the market is turning bearish. This is confirmed by the last candle.
Harami looks like the opposite candle to an engulfing one. In this, we have a large candle (either red or green) that is followed by a much smaller candle in body that is overshadowed by the initial candle.
In the image on the left is the bullish Harami. Although the Harami is not as convincing as the engulfing pattern, it is still a good indication of any possible reversal in the preceding trend. The Bearish Harami is seen on the right of the image and should also be monitored as a possible example of a reversal from an uptrend.
Three Method Formations
Comprised of 5 candles, a three method formation can either be bullish or bearish. The three method formation is usually identified by the three smaller candles of a different color that are within the range of the bigger candles.
In the image, on the left, we have the Bullish three method formation. The interpretation of this formation is that initially the buyers were in control and pushed the price up. However, the sellers are trying to take over the bullish trend. However, the buyers eventually overwhelm the sellers and the trend continues up.
The same interpretation on the downside can be gleaned from the Bearish Three Method formation that is on the right of the image.
Falling / Rising Windows
Similar to the Morning and Evening stars, falling and rising windows usually occur in times of market illiquidity. This is because there is a large gap down or up between the candles.
However, with the falling and rising windows the gap is way more pronounced as the candle opens far away from the open / close of the previous candle.
In the image we have the falling window on the left. It can be a sign of a Bearish Continuation pattern. The Rising Window on the right is a strong bullish indicator and should be a bullish sign of a potential rising trend.
Using CandleSticks with Binary Options
When trading Binary Options with Candlestick analysis, you will usually look to use expiry times that correspond to the timeframe of the candlestick. The trader will then enter either a CALL or a PUT option at the beginning of the next candle. Hence, if the trader is of the view that the candle will end up down (red) he will enter a PUT and vice versa for CALL.
Hence, given the candle stick pattern that the trader has observed, they have a fairly good idea about where the next candle will end up. We will go over a few examples of trading binary options with candlesticks.
Example 1: Spot Gold Candlesticks
In the image on the right, we have the Spot price of gold plotted on five minute candles. Hence, the trader should have a five minute binary option expiry selected.
As the trader can observe, there is a large red candle that is followed by a smaller green candle. This green candle is completely within the bounds of the larger red candle.
This is a Bullish Harami and it is a bullish indicator. The trader can therefore enter a 5 minute CALL option at the start of the next candle. This would have resulted in a profit on the expiry of the option.
Example 2: GBPJPY Candlesticks
Taking a look at the 5 minute candles of the Yen and GBP cross, we can see that there was a large gap down during the weekend as the GBP depreciated.
This is a falling window as the price has opened considerably lower and has also closed much lower. This is a Bearish indicator and the trader should enter a PUT option on the open of the new candle.
On the expiry of the option, the close was lower than the open and the trader would have made a profit.
Example 3: FTSE 100 Candlesticks
Candlestick analysis done with equity indexes can be equally effective. Taking a look at the 5 minute candlestick chart of the FTSE 100, we can see a large red candle that is followed by three increasing green candles and another large red candle.
This is a Bearish three method formation. On the open on the next candle, the trader should look to enter a 5 minute PUT option on the FTSE 100.
Given that the formation is a bearish indicator, the trader will likely have a trade that will end up closing lower and hence in the money. The trader can then profit from the fall.
Example 4: USDCAD Candlesticks
Sometimes, a candlestick formation can be a combination of more than one. Taking a look at the chart with the Canadian and US dollar cross, we can see that there is the tell-tale sign of Three White Knights.
However, the third white knight is considerably higher than the second one. This is a rising window and is also a bullish indicator.
Hence, the trader can be more certain of a positive outcome in the next candle. The trader will therefore enter a 10 minute CALL option on GBPJPY.
As the momentum from the three white knights and rising window takes hold, the option will expire in the money and the trader will profit.
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