The candlestick strategy is one of the most popular ways of trading binary options. When you understand candlesticks, you can find trading opportunities in any market environment, and you will always be able to trade a binary option.
In this article, we explain how to execute a candlestick strategy with binary options. In detail, we will answer these questions:
- What are candlesticks?
- How can I use candlesticks to trade binary options?
What are candlesticks?
Candlesticks are a way to help short-term investors find profitable trading opportunities. This way is necessary because, to find profitable trading opportunities, you first need to know what is currently happening with an asset. For long-term investing, you can look at things like a company’s earnings or its future potential, but for short-term trading with binary options, this information is useless.
Even if you know that BMW has the superior product compared to Renault, this knowledge does little to help you predict whether BMW’s stock will rise or fall over the next hour. There will be many days when BMW’s stock closes lower, even if they post record numbers every quarter, for example when the overall market is down or when there is bad news from another car maker. In an economic crisis, many companies’ stock price will be dragged down, even if the companies are doing extremely well.
The only way to know what is happening in the market in the short term is technical analysis, and candlesticks are one of the most essential tools of technical analysis.
Technical analysis is based on a simple assumption. The only factor to why an asset’s price is rising or falling over a short period of time is the relationship of supply and demand. It is impossible to tell where this supply and demand is coming from, and it is impossible to understand why traders are currently buying or selling, but it is possible to understand that they are currently buying or selling and whether the supply is exceeding demand or the other way around. This knowledge is enough to win a binary option.
- When supply is exceeding demand, you know that prices will fall. Consequently, it is a good idea to invest in falling prices.
- When demand is exceeding supply, you know that prices will rise. Consequently, it is a good idea to invest in rising prices.
Technical analysis shifts the focus from why something is happening to that it is happening. As long as you know that the market will rise or fall, there is no need to know why it is rising or falling.
Candlesticks are one of the most essential tools of technical analysis. Candlestick charts are a form of visualizing the price movement of an asset, which is why they are an essential tool for any technical analyst.
Compared to the line charts most traders know from the newspaper, candlestick charts have one major advantage: they provide you with all the market movements of an asset. Line charts only use one price per period.
To understand this difference, think of the limitations of a line chart. When you look at the market movements of one day, one month, or one year, a line chart is unable to display every single market movement – the chart simple is not that detailed. Consequently, the line chart has top aggregate the data into multiple periods and displays only one price per period, most commonly the closing price. The line chart ignores all other prices, which leads to significant inaccuracies.
A line chart denies technical analysts many of the information that they need to understand what is happening. Consider these two examples:
- Example 1: A period opens at a price of $100, remains at this price without much activity, and then closes for $100. The next period opens at $100, too. In a line chart, this market movement would result in a flat line between both periods.
- Example 2: A period opens at $100, moves to $102, and then falls back to close at $100 again. The next period opens at $100, too. In a line chart, this market movement would also result in a flat line between both periods.
In both of these cases, a line chart would display the market’s movements in exactly the same way – a flat line. Technical analysts would draw the same conclusions, even though both market environments are fundamentally different and should be traded differently.
Candlestick charts can solve this problem. A candlestick chart can compress all the information of a given time period into one candlestick. This enables you to get all the important information you need quicker than with a regular price chart and derive even more information, which you can use for your own candlestick strategy.
A candlestick charts compact, quickly accessible information helps you to apply certain strategies a regular price chart would not allow you to.
Each candlestick represents the price movement of a certain time interval from a few seconds to days and consists of a body and a wick.
- The body represents the opening and closing price of the asset in the given time period. Is the closing price higher than the opening price, the body color is usually white, and the candlestick is classified as bullish. Is the closing price lower than the opening price, the body color usually is black, and the candlestick is classified as bearish.
- The wick is the smaller extension in both directions of the body and represents the maximum price movement in the given time period.
Sometimes the body colors are replaced by red and green, gray tones, or other colors. Don’t get confused, these color schemes all work in the same way: there is one color for upwards candlesticks and one color for downwards candlesticks, and you should be able to understand intuitively which color represents which direction.
What candlesticks can be the basis for my candlestick strategy?
Candlesticks are ideal for technical analysts because their unique forms create patterns and formations. These formations can consist of one single candlestick with a special form or more candlesticks that create a certain pattern. A skilled trader can use these formations to predict future price movements. Often, one glance at the price chart is enough for skilled traders to understand where the market will move next.
There are too many candlestick formations to explain them all in one article. We will focus on a brief overview here.
Candlesticks are classified into two main categories:
- There are simple candlestick formations, consisting of only one candlestick, and
- Complex candlestick formations that consist of more candlesticks.
In the interest of clarity, we will present you with an example for each here and explain the details in specialized articles.
Simple candlestick formation example: the big candle
The Big Candle is an example of a formation created by a single candlestick. The Big Candle is characterized by an unusually large body that opens and closes very near the maximum high and low of the time period. If the candlestick is white, in other words in a bullish direction, this likely indicates the beginning of a longer bullish movement. If the candlestick is black, or in a bearish direction, this likely indicates the beginning of a longer bearish movement.
You can use this information to purchase options in the direction of the candle and predict further price movements in this direction. Which option type you should use depends on the timescale of your chart. On a smaller timescale, you should use options with a shorter expiration time, 30 seconds or 60 seconds options for example if your timescale is one minute or less. The larger your timescale, the more option types you can use. For example, when you trade a timescale of hours, you can use High or Low and Touch options.
Complex candlestick formation example: the 3-method formation
One example for a more complex candlestick formation is the 3-Method Formation. The 3-Method Formation builds on the Big Candle. Instead of a single Big Candle, it consists of a Big Candle followed by a number of smaller candlesticks included within the range of the Big Candle, but in the opposite direction.
The formation is completed by another Big Candle at the end that breaks out of the first Big Candle. This movement is predicting a price movement in the direction of the Big Candles, too.
When you learn to recognize a good amount of candlestick formations, your trading will benefit greatly. They can enable you to avoid bad trades you otherwise would have made and find new opportunities to make good profits.
Very complex candlestick formation example: The shoulder-head-shoulder formation
The shoulder-head-shoulder formation is a candlestick formation that can easily contain 50 candlesticks or more. It is an example of reversal patterns, which can tell you when a trend is over. The opposite of reversal patterns are continuations that indicate that a trend is likely to continue. For now, let’s focus on the shoulder-head-shoulder formation, you can find information on the other patterns in separate articles.
The shoulder-head-shoulder formation indicates that an uptrend has ended and a downtrend has begun. As you can see in the picture, the market has risen in a trend for quite a while but then ran out of momentum. The market went through a consolidation period but failed to pick up new momentum. As a result, he fell below the previous low of the uptrend, effectively ending the uptrend and starting a new downtrend.
This quick, decisive shift in market direction changes the market environment fundamentally. Where all signs previously pointed to rising prices, traders now have to expect falling prices. Consequently, they have to exit their long positions and invest in short positions, creating additional supply and reducing demand to a minimum, which results in a strengthened downwards movement.
This downwards movement is predictable, which means that, as a binary options trader, you can profit from it.
How can I trade a candlestick strategy with binary options?
To trade a candlestick strategy with binary options, you have a couple of options. In the following paragraphs, we will walk you through the process of creating your own candlestick strategy with binary options. This process includes three steps:
- Choose the right candlesticks,
- Choose the right binary options type, and
- Choose the right money management strategy.
Let’s take a closer look at each of these strategies.
Your own candlestick strategy with binary options, step 1: Choose the right candlesticks
Your first step in creating your own candlestick strategy with binary options is choosing the right candlestick formation to trade. As we have detailed above, you have three options:
- Simple candlestick formations,
- Complex candlestick formations, and
- Very complex candlestick formations.
Each of these formation has its own advantages and disadvantages.
Simple candlestick formations are the most common. Because they require only one candlestick, simply candlestick formations can form in any market environment at any time, and you should be able to find plenty of trading opportunities based on them.
The downsides to simple candlestick formations are that their predictions are only valid for the next candlestick and that they are the least reliable of all candlestick formations.
When you trade simple candlestick formations, you accept these limitations. If you know what you are doing, you should be able to turn a profit nonetheless, but you will win a lower percentage of your trades than with complex candlestick formations. This is not a problem.
The lower winning percentage of simple candlestick formations is no disadvantage because you can make up for it by investing in more trades. Since simple candlestick formations are the most common of all candlestick formations, they provide you with more trading opportunities than any other type of candlesticks. These added opportunities more than make up for the reduced winning percentage.
It is more profitable to win 70 of 100 trades than to win 8 of 10 trades. Simple candlestick formations exploit this relationship and provide you with the biggest earning potential of all candlestick formations. The downside of this high potential is that simple candlestick formations also contain the most risk of all candlestick formations. You will probably experience longer losing streaks, and you have to manage your money well to execute a strategy based on simple candlestick formations profitably.
More complex candlestick formations offer more security but less trading opportunities. Candlestick formations based on two candlesticks will form less often than those formations that require only one candlestick, but because the market took longer to create these candlesticks, their predictions are more reliable.
Very complex candlestick formations such as the shoulder-head-shoulder formation will allow you to win the highest percentage of your trades, but they form only rarely. After a shoulder-head-shoulder formation, the market will fall almost always, but you might only find one should-head-shoulder formation in an entire day of trading.
For you as a trader, it is important to base your candlestick strategy on the type of formations that suit your character. There is no right or wrong in this matter, and as long as you are able to make money by the end of the month, you have done everything right.
Your own candlestick strategy with binary options, step 2: choose the right binary options type
Once you have found the candlestick formation that you want to trade with your strategy, you have to decide how you want to trade it. Binary options offer you a number of different options to make predictions, and which option you choose will define the character of your strategy just as significantly as which candlestick formations you trade.
Binary options offer you these tools to trade the predictions generated of your candlestick formations:
- High / low options,
- One touch options, and
- Ladder options.
Each of these options offers a very different relationship from risk to reward, and in the case of ladder options, you can even significantly vary the risk/reward-relationship with one and the same binary options type. To understand these connections better, let’s look at each option type and how you can use it to trade a candlestick strategy.
How to execute a candlestick strategy with high / low options
With high / low options, you make the simplest prediction of all binary options types. All you have to do is to predict whether the market will be trading higher or lower than right now when your option expires. If an asset is currently trading at $100 and you choose an expiry of one hour, you can predict whether the market will be trading above or below $100 one hour from now.
If your prediction with high / low options is correct, you get a payout of around 70 percent to 85 percent. This means, if you invest $50 on a trade, you will make a profit of around $35 to $42.50.
With this system, you can make safe predictions for your candlestick strategy. To win a trade, it is enough if the market moves in the right direction by the smallest possible increment. When you trade a candlestick that indicates an upward direction, for example, a high option maximizes your chances of winning the trade. Any movement in the right direction will be enough, and you get your payout.
The downside to using high / low options to trade candlesticks is that they offer lower payouts than almost all binary options types.
With these characteristics, high / low options are ideal for traders that prefer the slow but steady approach to trading binary options. Winning one or two trades will hardly make you rich, but you can avoid longer losing streaks and win trades on a regular basis. Traders that like the feeling of winning most of their trades should stick with high / low options, too.
High / low options offer especially intriguing possibilities when they are paired with simple candlestick formations. Since simple candlestick formations offer the riskiest predictions, high / low options are the ideal tool to balance this risk and create a somewhat risk-sensible strategy that can nonetheless profit from the many trading opportunities that simple candlestick formations create and has a high earning potential.
As these two examples shows, using high / low options to trade candlesticks can be a very attractive strategy. Especially newcomers will find a strategy based high / low options much easier to execute than a strategy based on any other binary options type.
How to execute a candlestick strategy with one touch options
Compared to high / low options, one touch options offer a riskier alternative with higher payouts. One touch options allow you to predict whether the price of an asset will reach a certain target price at least once before your option expires.
You can trade all candlestick formations that work with high / low options with one touch options, too. Generally, switching to one touch options will reduce your winning percentage but increase your average payout, which is why trading candlestick formations with one touch options is a strategy that appeals to risk lovers.
There is, however, one major difference between high / low options and one touch options. In contrast to high / low options, one touch options do not require the price to remain at the target price. It is enough if the market touches the target price for the briefest possible time period, and you will win your binary option.
This difference makes one touch options the perfect binary options type for certain candlestick strategies. If you trade one of these strategies, using one touch options might allow you to increase your winning percentage and your payout. These strategies are:
- Traders that want to use the definite boundaries of continuation patterns to win a binary option, for example, will find that one touch options are the perfect tool for their purpose. They can simply choose the one touch option with the longest expiry that still offers a target price within the continuation pattern, and they are highly likely to win their option.
With a high / low option, the same trade would be more difficult to win. The market moves erratically within the limits of a continuation pattern, which makes it difficult to predict whether it will trade above or below a specific price at a specific time. It is much easier to predict that the market will reach a specific price at some point, and one touch options are the perfect tool to make this prediction.
- Traders that want to trade the breakout of a formation will find that one touch options are the ideal tool to make this prediction. Breakouts are short, strong movements that occur when the market completes a candlestick pattern and all traders now know for sure that the market environment has changed. This realization results in many orders, triggering a sudden surge in supply or demand, depending on the form of the candlestick formation. This movement is called the breakout.
As a binary options trader, you can trade the breakout with one touch options. Since the breakout is a very volatile movement, it is difficult to trade it with high / low options. With one touch options, however, you can predict that the market will reach the target price at some point and win a binary option.
On the other hand, you should be careful to combine one touch options with simple candlestick formations. The predictions of simple candlestick are risky enough as they are, trading them with one touch options is a strategy only absolute risk lovers should employ.
For all other types of strategies, one touch options present an interesting alternative to one touch options. If you like the basic characteristics of a specific type of candlesticks, you can change the entire nature of the strategy that you base on these candlesticks by switching from high / low options to one touch options.
How to execute a candlestick strategy, option 3: Ladder options
Ladder options take a special place in this list because they allow for two fundamentally different ways of trading candlestick formations. One of these ways is the safest way in which you can trade candlesticks, and the other is the riskiest way.
Ladder options work just like high / low options, in that they allow you to predict whether the market will close above or below a target price. In contrast to high / low options, however, ladder options do not force you to make this prediction based on the current market price. Instead, you can choose your target price freely from a list of available target prices. This system allows you to create two very different types of candlestick strategies.
Firstly, you can use ladder options to predict that the market will move strongly. When you predict that the market will trade above a target price that is above the current market price or below a target price that is below the current market price, you predict a strong movement. Consequently, you get a high payout of up to 1,500 percent, but you also accept the risk that a lot of things can go wrong.
Secondly, you can use ladder options to predict that the market will close above a target price that is below the current market price or below a target price that is above the current market price. These predictions are relatively secure – the market can even move in the wrong direction, as long as it moves not strongly. Consequently, you should be able to win a high percentage of your trades, but you will get a lower payout.
These two ways of trading ladder options make them an attractive tool for your candlestick strategy. You can use them in a number of ways:
- You can use ladder options to make the highest-risk/highest-reward predictions of all binary options types. Be careful to combine this way of trading with simple candlestick formations, they are already risky enough. For complex and very complex candlestick formations, on the other hand, ladder options can be a great tool to make a large profit despite limiting trading opportunities.
- You can use ladder options to add a low-risk profit to your strategy. When you expect a movement, you can use ladder options to make a safe prediction to the other side. In the case of an upwards movement, for example, you can predict that the market will close above a target price that is far below the current market price. These predictions will get you only a low payout, but you should be able to win such a high percentage of your trades that you can add a nice profit to your trading without risking much.
In these two ways, ladder options can add a nice spice to your strategy and offer you profits that no other binary options type can offer you.
Your own candlestick strategy with binary options, step 3: choose the right investment per trade
Once you have decided which candlesticks you want to trade and how you want to trade them, you have to define how much money you want to invest in each single trade. It is important to have a solid money management strategy because this is the only way to survive losing streaks and grow your capital when things go normally.
With a good money management strategy, you invest a fixed percentage of your overall capital on every single trade. Ideally, this percentage is somewhere between 2 percent and 5 percent.
With risky strategies, for example combining simple candlestick formations with one touch options, you have to expect longer losing streaks than with safer strategies. Consequently, you should adjust your investment per trade accordingly. Stick with a 2 percent investment in risky strategies and only invest 5 percent per trade when you know that you will win a high percentage of your trades.
Also keep in mind that you can adjust your investment per trade over time. It is, therefore, better to opt on the side of caution when you first define your strategy. If you find that a 2 percent investment per trade is safe and secure, you can increase your investment to 2.5 percent, then 3 percent, and so on. This secure approach is better than starting with a 5 percent investment and ending up broke.
Candlesticks are a way of displaying price movements that allow you to make easy predictions. A candlestick strategy can use these easy predictions to make profitable investments.
There are three types of candlestick formations on which you can build your candlestick strategy:
- Simple candlestick formations,
- Complex candlestick formations, and
- Very complex candlestick formations.
Complex formations allow for safer predictions but will offer fewer trading opportunities.
You can combine trade candlestick formations with high / low options, one touch options, or ladder options. By combining the unique risk/reward profile of these option types with different candlestick formations, you can create a strategy that suits your character perfectly.
Use the information you found in this guide, and you should be able to create a candlestick strategy that helps you to trade profitably and lead you the way to financial independence.