Being successful in binary options trading relies heavily on being able to spot patterns within the data. Patterns can indicate bullish and bearish markets, as well as aiding in the prediction of price reversals which makes them a key tool for analysis. Traders who can identify and use these patterns to their advantage are likely to enjoy success in the markets. One of the most popular patterns used by binary options traders is the Head and Shoulders pattern. As might be imagined from its name, the characteristic Head and Shoulders pattern has an appearance that matches its description, having both a left and right shoulder, left and right neckline and a head. This recognisable pattern is considered to be a reversal pattern that can be used to identify a market top. The Head and Shoulders Pattern serves as an alert to a trader that market movement is about to change and move in the opposite direction.
How to Recognise the Head and Shoulders Pattern
The Head and Shoulders pattern consists of three consective peaks, with the tallest being found in the middle of two peaks of roughly equal size. The structure looks similar to a head and shoulders, hence its name.
The Head and Shoulders pattern is formed in the following way:
The left shoulder will be formed as the market tries to create a new high, however it is met by a specific resistance level in selling.
The market will move lower, however it will be met by support causing a new uptrend that begins to produce a new high. This powerful up move is attractive to investors and this forms the head.
Having formed this top, the market will drop. However after it gets to the neckline, support will push it higher and as the price action again takes an upward turn the right shoulder will be formed.
The market is pushed back to the neckline because of selling pressure, eventually breaking the neckline and reversing the current trend.
In order for this pattern to be successful in trading, traders must wait for the pattern to reach completion.
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How to Use the Head and Shoulders Pattern for Binary Options Trading
The key to success in trading with the Head and Shoulder pattern is familiarity with the neckline, which is the average price point that lies between the low after the left shoulder and the low after the head. To use the pattern to trade, you need to look for the price going beneath the neckline after the right shoulder’s high point. The majority of traders will wait to execute their trade during a breakout, when there is no longer a linear pattern to the neckline. The profit target is the difference between the low price point of the shoulders and the high price point of the head. To get the downside trend profit target, the difference is found between the high price point of the head and the low price point of the shoulders from the neckline.
There are several ways that the Head and Shoulders pattern can be used for binary options trading, but these are some of the most popular:
Trading a Touch Option
When the right shoulder has been formed, one good strategy is to trade a touch option, as at this point you can make a fairly accurate prediction that the market will break through the formation’s neckline in the imminent future. There is an excellent chance of winning the investment if you can find a touch option within the reach of the distance of the upcoming movement. To ensure you make an overall profit, you should check the volume in the second shoulder’s movement. If it is much lower than that in the preceding movements you should be able to make a good profit.
Trading a High/Low Option
Once the breakout has occurred and the market has crossed through the neckline, it is likely that the market will cross back over the neckline a further time. As this is a predictable movement, many traders prefer to trade this pullback. If it is possible to find a touch option within the reach of the movement of the pullback over the neckline, a high payout is very likely. There are also some traders who like to wait until the pullback has finished its movement to make a trade. Once the pullback is complete, the market will probably not cross the neckline in the imminent future and therefore it is the right time to make a high/low option investment. If you predict that the market closes on the opposite side of the neckline at the end of the expiration time, you are likely to gain back a large percentage of your investment.
Other educational articles
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- Classic Market Technical Analysis With Former Resistance/Support Becoming Support/Resistance
- Understanding Classic Chart Patterns (PDF) (Recognia Inc.)
- Selected Readings on Electronic Commerce Technologies: Contemporary Applications: Contemporary Applications (Google books)
- Trading Beyond the Matrix: The Red Pill For Traders And Investors (Wiley Online Library)