Technical analysis is the use of price action and chart information to predict the future behaviour of the traded asset. Technical analysis therefore involves the use of technical indicators, chart patterns, pivot points and price action analysis. Some of the methods of analysis can be used in the following ways:
Chart Patterns
Chart patterns involve the use of triangles, rectangle patterns, channels, wedges, flags and pennants as well as various patterns that define tops and bottoms to determine the future behaviour of an asset. Used properly, they are very accurate tools for analysis.
Triangles
There are three triangle patterns:
a) Symmetrical triangle: Formed by an upper sloping trend line connecting the lower highs and a lower diagonal trend line that connects the higher lows. The bias is neutral, and therefore not suitable for trading the binary options.
b) Ascending triangle: Made up of a horizontal trend line that connects the highs of the price action and a diagonal trend line that connects the lows of the price action, which are gradually getting higher to form higher lows. The end-point of this pattern is a bullish break of the upper horizontal trend line, which can be used to trade the CALL and TOUCH/NO TOUCH options.
c) Descending triangle: Formed by a lower horizontal trend line that connects the price lows and a diagonal trend line that connects the highs which are gradually descending to form lower highs.
The end-point is a bearish break out, which can be used to trade the PUT and TOUCH/NO TOUCH options.
Channels
Channels are formed by two parallel trend lines. Three types of channels are seen depending on their direction:
a) Ascending channels connect higher highs and higher lows. They can be used for trading the CALL option, using the lower trend line as the entry point.
b) Descending channels connect lower highs and lower lows. They can be used to trade the PUT option, using the upper trend line as the entry point.
c) Horizontal channels are just what they are: horizontally oriented, where the price action is range-bound. They are suitable for trading the boundary option because their perfect horizontal range has clearly defined upper and lower price boundaries.
Wedges
Wedges are formed by two sloping trend lines, where the angle of slope of one trend line is greater than the other. There are two wedge patterns:
a) Rising wedge is formed when the angle of slope is greater in the lower trend line. The rising wedge can be used to trade the PUT option since it is a bearish pattern, as well as the TOUCH/NO TOUCH trade type.
b) Falling wedges are formed when the angle of slope is greater in the upper trend line. The falling wedge can be used to trade the CALL option since it is a bullish pattern, as well as the TOUCH/NO TOUCH trade type.
Candlesticks
Candlesticks are a form of price representation in the financial markets. Candlesticks can also be used to predict the future movements of the price of an asset. Certain candlesticks are branded as continuation patterns and others as reversal patterns. Of these two, binary options traders should concern themselves more with the reversal patterns. There are two types of candlestick reversal patterns:
Bearish candlestick reversal patterns: These are candle patterns that are of importance to the trader when they occur at the top of a trend.
(Courtesy of fxwords.com)
of the trend. The snapshots above and below show the most important bearish candlestick patterns in the market.
(Courtesy of fxwords.com)
These patterns are best used for trade entries when they occur at the same time as the following:
a) Price action is at a resistance pivot point (R1, R2, R3).
b) Stochastics oscillator lines cross at overbought levels (>75)
It doesn’t have to be complicated. Simply combining the bearish reversal candlesticks with these two scenarios will deliver an accuracy rate that approaches 95%.They identify when a bearish reversal of price action will occur, and can therefore be used to trade the PUT option.
Bullish reversal candlestick patterns: These are candle patterns that are of importance to the trader when they occur at the bottom of a trend. They identify when a bullish reversal of price action will occur, and can therefore be used to trade the CALL option.
These patterns are best used for trade entries when they occur at the same time as the following:
a) Price action is at a support pivot point (S1, S2, S3).
b) Stochastics oscillator lines cross at oversold levels (<25).
The snapshots below show the most important bullish reversal candlestick patterns.
Bullish candlestick patterns (moderately reliable)
Courtesy of fxwords.com
Traders who have difficulty identifying these patterns can use any of the candlestick pattern recognition software that can be purchased online.
Indicators
Technical indicators are usually combined with either candlesticks or chart patterns to produce trading signals. The two most important technical indicators for use in deriving binary options signals are the MACD indicator and the Stochastics oscillator.
Stochastics: The best use of the Stochastics oscillator in the binary options market is seen when it is combined with candlesticks, with pivot points and with channels to produce signals that can be used to trade the CALL and PUT options.
PUT option trade:
a) Price action of an asset is located at the any of the resistance pivot points at the same time that the lines of the Stochs cross at an overbought level.
b) Price action is at upper trend line of a descending channel and Stochs is at overbought level.
c) Bearish reversal candlestick pattern at the top of a trend, with Stochs at overbought level.
CALL option trade:
a) Price action of an asset is located at the any of the support pivot points at the same time that the lines of the Stochs cross at an oversold level.
c) Bullish reversal candlestick pattern at the bottom of a trend, with Stochs at oversold level.
MACD: One of the uses of the MACD indicator is in divergence trades. Divergences occur when prices are making higher highs and the MACD indicator is making lower highs or the price is making lower lows and the MACD is making higher lows.
The binary options trader should look for the occurrence of a divergence and use this as a signal for a CALL trade or a PUT trade, depending on the direction of the divergence.
In this chart, the price is making higher highs and the MACD indicator is making lower highs, the price is expected to correct itself in the direction of the MACD, which it does. The trader can take advantage of this setup with a PUT option trade.
Conversely, the MACD indicator can be used for a convergence trade, where the price action makes lower lows and the indicator makes higher lows. The price action is expected to correct itself to follow the indicator, and we look for a candlestick pattern to confirm this.
The snapshot above is for a MACD convergence. In both cases, the entry signal for the trade is when a reversal candlestick pattern forms. This is when the trader should execute the trade.