Trading Trend Reversal Patterns in Binary Options

What are the reversal patterns for binary options?

In binary options trading, reversal patterns are crucial in identifying potential shifts in market trends. These patterns indicate a change in the prevailing direction of an asset's price movement, providing traders with valuable insights for making informed decisions.

Before getting into specific reversal patterns, it's crucial to understand the concept of a trend in binary options trading.

A trend signifies the market's general direction — upward (bullish) or downward (bearish).

Reversal patterns are specific formations on price charts that indicate a potential shift in the current trend. These patterns can be grouped into chart patterns and candlestick patterns.

Chart patterns

• Head and Shoulders (SHS)

• Double Top/Bottom and Triple Top/Bottom

• Wedges

Candlestick patterns

• Engulfing

• Doji

• Shooting star

Indicator patterns

• Divergences

Head and Shoulders

This classic pattern depicts a head (highest peak) flanked by two lower peaks (shoulders) with a neckline connecting the troughs. A confirmed SHS suggests a potential downtrend reversal.

Example

Consider a chart showing a high, higher, and lower high — a classic head and shoulders pattern.

Inverted head and shoulders – bullish

The chart above shows an inverted SHS – it helps to identify the end of a downtrend and the beginning of a period of rising prices.

How to trade

Traders often initiate a short position when the price breaks below the neckline, anticipating a downtrend.

Double Top/Bottom

Two consecutive peaks (tops) or troughs (bottoms) forming a distinct resistance or support zone, indicating a potential trend reversal. Double top signifies a trend reversal after an uptrend, while Double Bottom suggests a reversal after a downtrend.

Example

Observing a currency pair reaching a peak twice before a decline — a precise double-top scenario.

Double Top

The weekly chart above shows a double top in the bitcoin market (although the pattern can form even on minute charts). Moreover, the second top is above the first one, as if trapping buyers who think that the bullish trend will continue and the price will reach $100,000 per coin.

How to trade

Get confirmation (for example, by seeing expanding bearish candles and increasing volumes). Find an entry point for a short position on the lower timeframes - for example, when a support level is broken.

Similar to Double Top/Bottom, Triple Top/Bottom indicates trend reversal with three peaks or troughs. But with three peaks or troughs, this pattern offers a stronger confirmation of a potential trend reversal.

Rising/Falling Wedges

These formations are characterized by converging trendlines, narrowing down towards a point, suggesting a potential trend reversal upon breaking out of the wedge. Wedges signal a reversal, with Rising Wedges indicating a potential bearish reversal and Falling Wedges suggesting a bullish reversal.

Example

Spot security forming converging trendlines, indicating a potential trend reversal.

Rising Wedge

The chart above shows a wedge pattern in the EURUSD market. Even though the price consistently showed the formation of higher highs and lows (a sign of an uptrend), the situation quickly changed to bearish.

How to trade

Trade in the direction opposite to the wedge, anticipating a reversal. Look for confirmation (e.g. rising volumes and expanding bearish candles). Consider opening a short position - alternatively, on a breakdown of the pattern's lower boundary or other support levels. Opening a short position on short-term recoveries can also be justified and may suit more conservative traders.

Engulfing

A longer candle engulfs the previous candle's body, signifying a solid shift in momentum, potentially indicating a trend reversal. Engulfing patterns involve one candle fully covering the previous one.

Example

A bullish engulfing pattern occurs when an upward candle follows a downward one.

Bullish Engulfing

Binary options traders should favour the bullish engulfment pattern if there is a prevailing uptrend in the background. The chart above shows how the breakout level test occurred. A bullish engulfment in this case means the end of the test and reversal of the short-term decline to the upside.

How to trade

Traders may enter a long position after identifying a bullish engulfing pattern.

Doji & Shooting star

The chart below shows two candlestick patterns, a doji (1) and a shooting star (2):

1. A Doji is a candlestick with an open and close at the same or nearly the same price, suggesting indecision in the market. The Doji is often part of other candlestick reversal patterns consisting of 2-3 candles.

2. A Shooting Star is a single candlestick pattern with a small body and a long shadow, signaling a potential reversal.

Doji & Shooting star

Although each of these 2 patterns can be considered separately, together they tell the story of how, after a period of indecision, the bulls tried to continue the uptrend but failed.

This should warn the binary options trader of a likely trend reversal in a downward direction.

Divergences

In binary options trading, divergence occurs when the price of an asset moves in the opposite direction of a technical indicator, such as an oscillator. This can signal a potential trend reversal or continuation.

Example

In the illustrated example of positive divergence, a noteworthy observation emerges. Despite the price continuing its descent and forming a lower low, the Relative Strength Index (RSI) demonstrates a contrasting behavior, showing higher lows. This divergence signifies a potential weakening of the downward trend in EUR/USD, as the price's negative momentum loses strength while the RSI suggests a positive divergence in market dynamics.

A bullish divergence

How to trade

When engaging in divergence trading, it's crucial not to depend solely on divergence signals for trading decisions. Look for additional confirmation signals, such as:

• Candlestick Patterns: Watch for bullish Hammer or Engulfing patterns occurring after the identified divergence. These patterns can strengthen the case for a potential reversal.

• Support/Resistance Levels: Check if the price aligns with known support or resistance levels at the time of the identified divergence. Confluence with these levels can enhance the likelihood of a market bounce.

• Entry Point: Consider initiating a long position once the confirmation signals have manifested. Determine an appropriate expiry time based on your risk tolerance and the prevailing market volatility.

• Stop-Loss: If the trend persists in the opposite direction, strategically place a stop-loss order below the recent swing low to mitigate potential losses. This risk management measure helps safeguard your capital during adverse market movements.

Best binary options brokers

1

9.4/10

Go to broker

Your capital is at risk.

Minimum deposit:

$5

Review

CloseOption is a binary options broker that was registered in Georgia in 2013 and operates under the supervision of the National Bank of Georgia. It provides its clients with trading in pairs with fiat currencies and cryptocurrencies through a proprietary web platform. CloseOption’s services are used by over 2 million traders worldwide, including the United States. The broker specializes in active options trading but also offers an affiliate program to generate passive income. More than ten payment systems are available to CloseOption clients for depositing and withdrawing funds, with the majority of them allowing fee-free transactions.

Pros/Cons

•licensed by a reputable financial regulator;

•loyal first deposit of $5;

•size of payments increases as trading volumes increase;

•money prizes for trading with virtual funds;

•many ways to contact technical support that operates 24/7.

•a small range of trading assets;

•clients cannot trade with leverage;

•payments on accounts with small deposits are lower than those of competing brokers.

Study Review

2

9.2/10

Study Review

Minimum deposit:

$250

Review

Nadex is a binary options broker working mostly with US and EU traders. The company was founded in 2009, officially registered in the State of Illinois, and regulated by US law. The broker's regulator is the CFTC (Commodity Futures Trading Commission). The main competitive advantage of Nadex is its completely transparent work, controlled by one of the most reputable regulators in the world. A distinctive feature of the broker is unique binary options products and direct access to the US exchanges.

Pros/Cons

•regulation by CFTC;

•binary options toolkit is easy to use.

•the broker works through an intermediary from the EU;

•commission for each trade is US$1;

•limited range of offered products (3 types of options);

•all information on the site is in English only;

•complex verification procedure that meets the requirements of US legislation;

•high entry threshold - $250;

•there is a flat fee for withdrawing money - $25.

Study Review

Is reversal trading profitable?

Whether reversal trading is profitable is a complex question with no simple answer. It depends on various factors like your trading skills, risk management, and the specific trading strategy you use.

The choice to trade breakouts or reversals also depends on personal preference. If by nature you are close to selling at the highs and buying at the lows, consider the pros and cons of trading reversals. This trading style may be more suitable for you.

If you are wondering if you can benefit from trading reversal patterns, try doing it on a demo account first. More details for beginners - in the article: How to Start Binary Options Trading in 7 Simple Steps.

Tips for trading reversal patterns

Trading reversal patterns require a strategic approach to maximize potential returns while managing risks effectively. Here are essential tips to enhance your understanding and improve your success rate in identifying and trading these patterns:

• Look for Patterns at Support or Resistance Levels
  Understanding the context in which reversal patterns form is crucial. Focus on identifying patterns that occur at significant support or resistance levels. These levels provide additional confirmation and increase the probability of a successful reversal.

• Use Multiple Indicators to Confirm the Pattern
  Enhance your analysis by incorporating multiple indicators that complement your identified reversal pattern. Combining technical indicators such as moving averages, RSI (Relative Strength Index), or MACD (Moving Average Convergence Divergence) can provide additional confirmation, strengthening your trading decision.

• Back-Test Your Reversal Strategy
  Conduct thorough back-testing using historical data before implementing your reversal strategy in live markets. This process involves applying your strategy to past market conditions to assess its effectiveness. Back-testing helps identify strengths, weaknesses, and potential areas for improvement in your approach.

• Control Risks and Never Overcommit
  Risk management is a cornerstone of successful trading. Set clear risk limits for each trade, and ensure you only invest what you can afford to lose. By defining and adhering to your risk tolerance, you protect your capital and maintain a disciplined approach to trading.