The island reversal is a significant candlestick formation that allows for accurate predictions about future market movements.
Characteristics of the Island Reversal
The island reversal is a candlestick pattern that features only few candlesticks but allows for a strong prediction nonetheless.
Island reversals usually occur after the market has been moving in one direction for a while. At some point, the market creates a gap in direction of the movement. During an upwards movement, this gap would be upwards. During a downwards movement, this gap would be downwards.
This advancement, however, is short lived. The market might stay at the new level for a few periods, but soon thereafter the market will create a gap in the opposite direction of the first gap and fall back to the price level before the first gap. This event is a strong indication that the movement lacks the power to maintain higher prices. Apparently, there are only few traders willing to invest in the direction of the movement.
Generally, the island reversal’s first gap is considered to be an exhaustion gap. While exhaustion gaps can also be discovered by analyzing the trading volume, the island reversal is an even stronger indication of an exhaustion gap. The island reversal’s second gap is considered to be the result of a breakaway gap. Usually, the second gap will be accompanied by a significantly higher volume than the first gap.
Both gaps combine to create a strong indication of a market turnaround. Therefore, you should consider an island reversal always as a strong, close to certain indication of a reversal and trade it accordingly.
In that sense, the island reversal indicates an impending movement in the opposite direction of the preceding movement: If the island reversal occurred after an upwards movement, the market is likely to turn downwards. If the island reversal occurred after a downwards movement, the market is likely to turn upwards.
How to trade the island reversal
As a binary options trader, you can use the island reversal’s indication to win a binary option. The most obvious and likely the safest way to trade the island reversal is to invest in a high / low option in the opposite direction of the preceding movement once the second gap has occurred.
In that case, you should use a short to medium expiration time of only a few periods. Make sure to give the movement enough time to develop, but do not choose the expiration time too long, or your binary option will expire after the movement is already over.
Another possibility to trade the island reversal is to use touch options. For that strategy, you need to be able to predict how far the market will move. You can use technical indicators, especially momentum indicators such as the average true range or bollinger bands, and resistance and support lines to make that prediction. There are plenty of different strategies how to predict the possible reach of a movement. To understand them, please read the according sections.
Using boundary options to trade the island reversal, on the other hand, does not make much sense. The island reversal very strongly indicates the direction the market will move in. Therefore, there is no sense in wasting the additional earning potential of touch options for the small advantage of covering both directions with boundary options.
Similarly, 30 or 60 seconds options are not a good fit to trade an island reversal. Usually, their expiration times are simply too short.