In previous articles, we already discussed trends and trend lines. In this article, we will go into detail with one of the trend’s main component: The reversal.
How to recognize a reversal and what to expect
As we already have established, each trend is defined by three kinds of major points.
- Point 1 (the starting point of the trend),
- Several point 2s (one for each new peak in an upwards trend, or one for each new low in a downwards trend), and
- Several point 3s (one for each new low in an upwards trend, and one for each new peak in a downwards trend).
A reversal is the price movement from point 2 to point 3.
Most traders shy away from trading the reversal. They are unsure how far the price will reverse, and therefore rather trade the longer movement from point 3 to point 2. Since binary options focus on short-term investments, a binary options trader has to be able to trade successfully in any kind of market environment.
Therefore, you have to be able to predict how far the reversal will move before the trend will resume its main direction. A number of instruments can help you with that. First of all, there is the trend line. Once you have established the main trend line for a trend, you know the maximum movement you can expect from a reversal. As long as the price is far away from the trend line, you should try to find trends in smaller time frames.
Trading the reversal with binary options
As any price movement, the reversal consists of a number of smaller trends. The best way to trade the reversal is to look for these trends, and wait for the price level to move above or below the previous point 2, depending on the direction of the trend. This will trigger many limit orders and stop loss orders by other traders, and create a big price movement in the direction of the reversal. You can trade this movement with a High/Low option in the direction of the reversal and a short expiration time. Some of these smaller trends can be recognized from the same time frame as the main trend. For others, however, you will have to switch to a smaller timeframe, and trade the trend there.
As the price approaches the trend line the price movement will get more and more erratic. Other traders have recognized the trend line, too. They are no longer investing in the reversal and wait for the price to start moving in the direction of the main trend again. At the same time, they are not willing to invest just yet, since they wait for the price to turn first. Therefore, this time is characterized by a low trading volume. Supply and demand exceed each other randomly, and the price moves up and down erratically.
As a binary options trader, you have to make a prediction about the direction of the market. In this market phase this is almost impossible. The smart thing to do is to wait for the price to start moving up again. If you want to trade these phases anyway, you should search for trends in smaller time frames and trade only options with very short expiration times. These sorts of trades require a lot of skill and experience to be executed successfully. New traders should focus on other trading phases.
Another instrument that can help you predict how far the reversal will move is the candlestick strategy. There are a number of candlestick formations, some of which indicate an impending change in price direction. If these occur near the trend line, you can invest in raising prices for the future.