• Category: Strategies

Leveraging Trend Reversals To Avoid Losses in Options Trading

As a trader, how do you determine when to enter the market? How do you know it is time to get out? How about predicting whether you should get into another trade to leverage the prevailing market conditions?

Analyzing trend patterns is an important skill that allows you to either make the most mileage on an emerging trend to maximize profits or to exit the market to avoid losing money. Generally, there are two types of trading trends: Continuation trends and Reversal trends. We’ll cover the trend reversals here and how you can use this to predict when to enter or exit the market.

What is a trend reversal?

First, let’s get clear about what a trend is. A trend is a visual indicator of the price movement of an asset within a specific period. In binary options, periods can be as short as 60 seconds and as long as a month.

A trend reversal takes place when the price movement of an asset takes a stronger downward trend than an upward trend.

Reversal patterns, like all price patterns, are made of the following four pieces:

  •     Old trend: the trend that the stock price is in as it starts to form the price pattern
  •     Consolidation zone: a constrained area defined by set support and resistance levels
  •     Breakout point: the point at which the stock price breaks out of the consolidation zone
  •     New trend: a reversal of the old trend that the stock price enters as it comes out of the consolidation zone


You can use the reversal strategy to determine the appropriate time to purchase an option. Traders who use this strategy typically wait for the asset price to move in a certain direction with the underlying assumption that the extreme price point will only last for the short term.

It is usually best to buy the option at this point (when the asset’s price point is at the extreme). A trader stands to profit when, after a short while, the asset price reverses to its initial price point.

The fundamental assumption defining the reversal strategy is this: When the price of an asset moves in a certain direction, it is likely to reverse back to its original position. As such, depending on whether the price has peaked or plummeted, a trader may purchase a call option or a put option, with the assumption that that the price will come back to its initial position.
While you can use technical indicators such as Bollinger Bands (or the sophisticated Commodity Channel and Relative Strength Indices, and the interesting Ichimoku clouds) to predict the price movement of assets, a simple place to start is looking at the different pattern formations on the price graph to determine whether there is a trend reversal or a continuation to leverage.

trend reversal

Conclusion

Understanding trend behavior is every important for the trader to earn high profits. Identifying a trend pattern, identifying when it started and when it is going to end are the most important tasks, because these will decide what strategy and expiry time is to be used for trading binary options.



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