Elsewhere on the site, we have presented simple and complex candlestick formations. You may well have spotted that several such formations are fairly similar to each other, and that some are simply more advanced versions of others. To begin with, this might seem confusing to some traders. Learn more in our article Comparing Candlestick Formations here.
In order to heighten your understanding of different candlestick formation and how they can be interpreted, we will in this article Comparing Candlestick Formations, describe three of the most important ones: The Big Candle, The Harami, and The 3 Method Formation.
We will analyze the market conditions that they each indicate, and tell you how to trade these different candlestick formations.
Comparing Candlestick Formations: Let’s start off with a quick reminder as to what the purpose of using candlesticks is. We are not attempting to reach a fundamental statement regarding the asset in question. We are not suggesting that the price of the stock should go up or down as a reflection of the company’s performance. Nor are we looking for conclusions regarding why a currency will move in a certain direction.
Rather, we take it for granted that all such information is already affecting the price. We can say that it is included in the price. That is to say: if we can figure out if the price is moving up or down, there’s no need to find out why. The direction of the price is all we need in order to make a good binary options investment. This is the logic that makes candlestick formations so useful to binary traders.
Let’s begin with the Big Candle. For simplicity’s sake we will only deal with bullish examples in this article. Naturally, all the points we make will apply in reverse for bearish formations also.
The body of a Big Candle is fairly large in comparison to nearby candlesticks, which indicates a large price movement. The opening and closing price are close to the highest and lowest prices overall during the time period. This tells us that traders were purchasing this asset throughout the time period, and continued to do so until it was over. For this reason, we can conclude that upwards momentum remains, and that this will persist into the following candlestick. The price will continue to rise, which is all you need to know in order to make money on a binary option.
The prediction The Big Candle offers can lose its validity if a smaller bearish candlestick that is contained within it appears. Such a constellation is a bearish Harami. This formation indicates falling prices.
Clearly, there is a logic behind this. The big candle predicts rising prices, but this didn’t happen. It is clear that the upwards momentum had run its course and bearish movements had prevailed. Movements such as this can cause some traders to distrust Big Candles in general. They feel that something that can prove to be incorrect all of a sudden is not to be trusted.
Alas, the confusion doesn’t end here. In cases where there is not only one candlestick contained within the big candle, but two or even more, and the formation is bookended with another big candle, the formation is what is called a bullish 3 Method Formation. This formation indicates that the prices will increase. As you can see, this is the second complete reversal of the prediction indicated.
Also here, the logic is obvious. After the Big Candle had caused prices to rise all the traders who wished to buy the asset had done so. As a consequence, the price needed to consolidate briefly. At this stage, new demand was created and prices rose once more.
A very important lesson is that a signal becomes more valid if it contains more candlesticks. You shouldn’t judge a book by its cover, and the same is true for candlesticks: the more you read, the better you will understand the messages they convey. Having said that, simple candlestick formation can also prove to be of worth. Generally speaking, you should choose which signals to act on depending on what sort of a trader you are.
This, like so many other aspects of binary options trading, is a choice between high-risk and low-risk. Clearly trading a Big Candle entails a higher degree of risk than trading a 3 Method Formation. As a consequence, you will need to be prepared to lose more trades by following such a methodology. On the other hand, risk-takers will accept this seeing as trading Big Candles will offer many more possible trades. This means that there can be big profits to be made in the short-term by doing this than waiting around for 3 Method Formations to appear.
In general we can conclude that risk-averse traders ought to stick to complex candlestick formations, whereas risk-takers might be better off with simpler candlesticks.