Nearly every trader of Binary Options or Forex has heard of the Elliott Wave Theory and is probably fascinated by the concept. However despite its popularity, Elliott Wave is also the least correctly understood theory of technical analysis. Too many binary options traders have found the numerous rules behind Elliott Wave Theory to be overly complicated and subjective. For those who correctly understand the rules, Elliott Wave Theory has proven to be a reliable basis for interpreting and forecasting price action. For those who misinterpret the rules, incorrect forecasting will lead many to conclude that Elliott Wave Theory is obsolete. Nevertheless, many traders have used Elliott Wave Theory to successfully identify turning points in price action.
Elliott Waves Theory: The Basics
Developed by Ralph Nelson Elliott in the 1930s, Elliott Wave Theory was originally designed to forecast stock price movement. Overtime however, the theory has been applied to a variety of markets, particularly foreign exchange. Its higher popularity in the foreign exchange market stems from the fact that 80% of the volume in the FX market is speculative. This is important since waves are based upon mass psychology. Elliott Wave Theory is now a very popular analytical strategy frequently used by the technicians of leading investment banks and inter-market players and individual traders of both Forex and Binary Options..
The Elliott Wave Theory is founded on the notion that markets are not perfectly efficient. As a result, prices from one moment to the next are not random but rather subject to changes in overall investor behavior—changes that can be predictable with an understanding of mass psychology.
How to count Elliot Waves
Before understanding the waves within the Theory, it is important to remember the tenet that every action creates an opposite reaction. Applying this thought to Elliott Wave, let us take a look at the most basic wave structure. The center of the Elliott Wave Theory rests on the idea that security prices move in waves: impulsive (going in the direction of the underlying trend) and corrective (going against the underlying trend). As indicated in the diagram below, there are 5 impulsive waves and 3 corrective waves. There are of course waves within waves that we will touch upon later in the guide.
Impulsive and Corrective Waves
To fully understand the Elliot Wave Theory, it is important to understand the psychological rationale for each of these waves since the zigzag movement of prices represents the ebb and flow of investor optimism and pessimism. Given an up trending market:
Wave 1 (Impulsive): Minor Up-wave In Major Bull Move – In Wave 1, prices rise as a relatively small number of market participants buy a currency pair for either fundamental or technical reasons, pushing prices higher.
Wave 2 (Corrective): Minor Down-wave In Major Bear Move – After a significant run-up, investors may get fundamental or technical signals indicating that the currency is overbought. At such time, Wave 2 develops when original buyers decide to take profits while newcomers initiate short positions. Price action reverses, but generally does not retrace beyond its initial low that attracted buyers at Wave 1.
Wave 3 (Impulsive): Minor Up-wave In Major Bull Move – Often the longest wave of the five, Wave 3 represents a sustained rally, as a larger number of investors use the Wave 2 dip as a buying opportunity. With a broader range of buyers, the security enjoys a stronger push higher, with prices extending beyond the top formed at Wave 1.
Wave 4 (Corrective): Minor Down-wave In Major Bear Move – By Wave 4, buyers begin to become exhausted and again take profits in reaction to overbought signals. Generally, there is still a fair amount of buyers, so the retracement here is relatively shallow.
Wave 5 (Impulsive): Minor Up-wave In Major Bull Move – Wave 5 represents the final move up in the sequence. At this point, buyers as a whole are motivated more by greed than any fundamental justifications to buy, and bid prices higher irrationally. Prices make a high for the move before a correction or reversal ensues. The high in Wave 5 often coincides with a divergence in the relative strength index (RSI).
A-B-C Corrective Waves
Wave A: Correction to Rally – Initially Wave A may appear to be a correction to the normal rally. However, if it breaks down into five sub-waves, it indicates that a new market trend may have developed.
Wave B: Bear Market Correction – Wave B tends to give bears an opportunity to sell as others take profit on their short trades or exit their long positions.
Wave C: Confirms End of Rally – Wave C is the last wave of the cycle. At this point, Wave 3 typically breaks key support zones and most technical studies confirm that the rally has ended.
Wave Count Rules:
While determining waves can be extremely subjective, there are three rules to counting waves that always hold. These rules form the basic tenets of Elliott Wave Theory.
Rule 1: Wave 2 cannot retrace more than 100% of Wave 1
Violation of Rule 1:
Rule 2: Wave 4 cannot overlap Wave 1
Violation of Rule 2:
Rule 3: Of waves 1, 3, and 5, wave 3 can never be the shortest wave (it is, in fact, often the longest)
Violation of Rule 3:
Waves within Waves:
The primary reason why Elliott Wave Theory can be difficult to understand is because waves frequently occur at many different levels. In other words, there are minor waves within larger waves. That is why at many points in time, multiple correct wave interpretations usually exist. The major waves determine the direction of the trend, while the minor waves help to determine the minor trends. Used in conjunction, traders can apply Fibonacci ratios to Elliott Wave Theory to help determine when currencies will reach a top or bottom.
It can also be used as a tool to identify points to trade within the trend or to participate in the shorter minor wave cycles. It is important for Elliott Wave traders in Binary Options to be aware of both the minor and the major waves that may exist. The following is an example of two minor waves within larger waves:
Minimize Forecasting Errors with Elliott Waves:
Since many different waves can exist during the same time frame, increasing the risk of forecasting error, traders should follow certain rules to minimize risk. The most important of which is to follow the principle that the “the trend is your friend.” This means that it is more prudent to only look for opportunities sell into minor waves when the major wave is a downtrend and to buy when the major wave is an uptrend. More rules can be used though to determine levels for placing stop-loss orders or to exit the trade. Fibonacci ratios are one of the most useful ways of identifying possible peak or bottoms of wave cycles. A popular relationship that exists is that Wave 2 retraces 38% of Wave 1. 50% and 61.8% retracements are also frequently seen.
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other instruments. This is because you only need to form a view on what direction
the price of the underlying asset will move. In comparison, traditional options also require you to form a view on the magnitude of any price movement.
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Binary options offer a way to trade stocks, commodities, indices and currency pairs where your rate of return is FIXED. You just need to correctly pick whether the value of the asset is going up (Call) or down (Put). Usually, these options expire in range between 5 seconds to weekly expiries.
From the above example, a trader forms a view that the price of gold will fall in a given period of time, and so places $100 in a put. If correct, He/She wins a fixed payout of $175. It does not matter if the price of the asset falls $1 or $100; the payout is the same. If the price of gold rises, however, the trader loses the entire amount of the investment – $100
Some brokers, let you minimize risks by choosing the payout and loss percentage. For example, you can choose to lose only 75% in the event that your view is incorrect. With such an option, you would also have to accept a lower win percentage.
Trend reversal patterns are essential indicators of the trend end and the start of a new
movement. They are formed after the price level has reached its maximum value in the
current trend. The main feature of trend reversal patterns is that they provide information
both on the possible change in the trend and the probable value of price movement.
These patterns serve to indicate to binary options traders, that the ongoing trend is about to change the course. A pattern formed during an uptrend signals a trend reversal where the price will head down soon. On the other hand a reversal chart formed during a downtrend indicates that the price will move up.
One of the key factors to recognize a chart pattern is to know where certain patterns are
most likely to occur in the prevailing trend. Patterns occurring at market tops are known
as distribution pattern, where Binary Options traders more enthusiastically sell than buy the trading instrument. Conversely, patterns occurring at market bottoms are known as accumulation patterns, where traders more actively buy than sell the trading instrument.
Head and Shoulders:
Head and shoulders indicate both the end of trend and the possible change in the direction of asset’s price. The given pattern is formed in an uptrend representing three peaks of the market price arranged at different levels. Two lower peaks called shoulders are located at two sides of the highest peak called the head.
The pattern’s lows are connected by support level called a neckline. If the price falls below the neckline or support level a sell signal arises. Though prices may rebound to the neckline forming a resistance level it is expected that the decline will continue.
Inverse Head and Shoulders:
Inverse head and shoulders represent a trend reversal pattern indicating the change in direction of the asset’s price. Being formed in a downtrend this pattern comprises three consecutive lows of the market price which are arranged at different levels: two
higher bottoms called shoulders are located at two sides of the lowest bottom called head.
The pattern’s highs are connected by resistance level called a neckline. If the price climbs above the neckline or resistance level a buy signal arises. Though prices may rebound to the neckline forming a support level it is expected that the surging will continue.
Double top represents a trend reversal pattern which precedes existing trend reversal. Though it is formed in an uptrend there is an expectation that it may be followed by a drop in prices. Moreover, if it takes much time for the pattern to be formed more reliable it will be. This pattern comprises two horizontal lines (support and resistance levels) connecting two most recent highs and a low of the price. When the market price breaks the pattern’s low or support level the formation is considered completed. In such a case it identifies downward direction of the trend serving as a signal to sell.
Double bottom represents a trend pattern which serves as an existing downtrend reversal.
Though it is formed in a downtrend there is an expectation that it may be followed by a rally in prices. Moreover, if it takes much time for the pattern to be formed more reliable it will be. This pattern comprises two horizontal lines (support and resistance levels) connecting two most recent low and a high of the price. The two recent lows form a support level and the most recent local high is considered a resistance level.
The formation is considered to be completed when the market price breaks above the pattern’s maximum or resistance level. In such a case it identifies upward direction of the trend serving as a signal to buy.
Triple top is a price pattern which is formed in an uptrend and is followed by a drop in prices. This pattern comprises three consecutive peaks arranged at the same level and two bottoms. The highs and lows of the price are connected by resistance and support lines.
The formation is considered to be completed if the price breaks the pattern’s minimum. It can be interpreted as a downward direction of the trend serving as a signal to sell.
Triple bottom is a price pattern which is formed in a downtrend and is followed by a rise in prices. This pattern comprises three consecutive lows arranged at the same level and two highs located between them. The lows and highs of the price are connected by support and resistance lines respectively. The formation is considered to be completed if
the price breaks the pattern’s maximum. It can be interpreted as an upward direction of the trend serving as a signal to buy.
Diamond is a trend pattern serving as a confirmation of the existing trend reversal. Generally it tends to appear in an uptrend. This pattern is formed of four limited trend lines which represent two support lines below and two resistance lines above. Those support and resistance lines connect recent lows and highs respectively thus forming a figure which visually resembles a brilliant or a rhomb. The formation can be thought to be completed when the support line at the right is violated. Therefore it can be interpreted as a downward direction of the trend serving as a signal to sell.
In conclusion, it would be important to note that a reversal pattern does not necessarily suggest a complete reversal in trend. It merely indicates a change or pause in direction. This can signify anything from a slowdown in trend, sideways trading after an established trend, or a full turnaround following a reversal candle pattern.
This article provides insight into the two major methods of analysis used to forecast the behavior of the financial markets. Technical analysis and fundamental analysis differ greatly, but both can be useful forecast tools for binary options traders. They have the same goal – to predict a price or movement. The technician studies the effect while the fundamentalist studies the cause of market movement. Many successful binary options traders combine a mixture of both approaches for superior results.
Technical Analysis Technical analysis is a method of predicting price movements and future market trends by studying charts of past market action. Technical analysis is concerned with what has actually happened in the market, rather than what should happen and takes into account the price of instruments and the volume of trading, and creates charts from that data to use as the primary tool. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments simultaneously. Technical analysis is built on three essential principles:
1. Market action discounts everything! This means that the actual price is a reflection of everything that is known to the market that could affect it, for example, supply and demand, political factors and market sentiment. However, the pure technical analyst is only concerned with price movements, not with the reasons for any changes.
2. Prices move in trends: Technical analysis is used to identify patterns of market behavior that have long been recognized as significant. For many given patterns there is a high probability that they will produce the expected results. Also, there are recognized patterns that repeat themselves on a consistent basis.
3. History repeats itself: Forex chart patterns have been recognized and categorized for over 100 years and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little over time. Forex charts are based on market action involving price. There are five categories in Forex technical analysis theory:
• Indicators (oscillators, e.g.: Relative Strength Index (RSI)
• Number theory (Fibonacci numbers, Gann numbers)
• Waves (Elliott wave theory)
• Gaps (high-low, open-closing)
• Trends (following moving average).
• Renko charts consist of brick-shaped bars, stood on end..
• Each brick represents x pips of movement up, or x pips of movement down. x is a
user input. In this picture, each brick is 10 pips. Renko charts are independent of time-frames. A new brick only starts when the previous
one has moved x pips. The yellow arrow is pointing towards a brick under formation. It
looks like the standard candle we are all used to seeing, because the price has to move a
full x pips (in this case 10) either up or down from its open price before it becomes a brick
and the next one forms.
As illustrated, the bricks do not show the full extent of up and down movement in the price whilst they have been forming. It is possible to generate bricks that also show wicks. Whether to have, or not have, wicks is a personal choice that depends on what you are trying to do. The body of the brick always represents your choice of x pips movement
either up or down. Why do some binary options traders use Renko bricks? Primarily, this is because each brick represents solid movement in the direction of the brick.
• Rising bricks are only created when the market has moved x pips up from the close high of the previous one.
• Falling bricks are only created when the market has moved x pips down from the close-low of the previous one.
• The price has to move x times 2 (20 pips on this chart) for the bricks to change
colour. This means we are basing our trading decisions on pure price action; time does not come into the equation.
• In a quiet market, bricks will take a long time to form.
• In a rapidly-moving market, they will form quickly. Whether to have, or not have, wicks is a personal choice that depends on what you are trying to do.
Binary Options trading strategies are a dime a dozen. There’s a lot of training available that addresses a specific Binary Options trading strategy or methodology. In many cases, though, there is not adequate instruction provided about the underlying mechanics that create those trading opportunities. I refer to those underlying mechanics of price behavior as strong, organizing principles of the market.
The basis for many binary options trading strategies is a price setup. A setup is recognizable formation that occurs on a chart. It offers the potential for a profitable binary options trade. There are many different price setups that form as a result of the strong, organizing principles of the market. Thus, if you’ll take the time to learn those principles through in- depth study of technical analysis (charting), and also learn how to execute binary options trades effectively, you’ll have the knowledge base to understand almost any binary options strategy In fact, you’ll be able to develop your own strategies if you choose. But if you prefer to utilize strategies developed by other traders, you’ll have the knowledge needed to understand and execute a strategy and to tweak it to fit the current market conditions, which in turn will help you become a better binary options trader.
If you were to review dozens of binary options trading strategies, you’d likely find that the premise of most of them has to do with price behavior that tends to be repeated. The setups develop because market participants react in certain ways causing those repeating patterns to form on charts. Once you understand why and how a setup forms, you can learn to recognize it as it is developing at the right edge of the chart so you can profit from it.
To succeed as a binary options trader, you have to get your conscious and sub conscience mind working for you. You must have a winning attitude, which can be achieved by surrounding yourself with positive events and introducing yourself to self-motivating or positive attitude tapes or books. Some call such ability an inherent feel for the market. Even better, they have the ability to act swiftly and execute a trading plan. I believe that these are talents that you develop and are not born with. Successful binary options traders were, are, and always will be students of the markets. They are achievers who continuously study, in perceptive detail, people’s actions, the processes of events, and the products in the markets they trade. When they place a trade, it is an educated decision, not merely a guess, and they know it. That knowledge gives them the confidence to execute and act on trading decisions. Confidence or thoroughly believing in yourself may come naturally or from the secure feeling you had when growing up.
Other ways to gain confidence in yourself might have come from overcoming an obstacle or having a successful experience in conquering some adversity in life. You consciously know that you have achieved or overcome challenges and can succeed due
to a past experience. Building confidence in yourself and in your binary options trading skills is extremely important in stimulating an optimistic winning attitude. The other common feature that successful traders seem to have is they are not afraid to be wrong. They realize that anticipating a market move will always include an element of risk. They act, not react, to market conditions. This means they place orders before the market moves rather than wait until after the market reacts to a situation or event. In my experience, those who hesitate or wait or are not prepared seem to have the most trouble capturing the element of success when it comes to trading futures.
The first step to improving your Binary Options trading results requires the ability to examine your actions and do a thorough, honest self-evaluation. Let’s call it taking an inventory of your actions and how you react emotionally to a situation because, after all, you are the most important part of the trading equation. In an interviewed with Mark Douglas, author of The Disciplined Trader and Trading in the Zone, he offered the idea that every outcome of a trade decision based on a technical chart pattern is a
random act. It is not a 100 percent guarantee that a chart pattern that resembles a bull flag will extend higher every single time. The problem is not the chart or the market but the actor, Douglas contended. I have found one popular phrase that often leads investors down the road to the poorhouse, either from actual monetary losses or from missed opportunities. I heard it from all different types of people. It did not matter what gender they were or what part of the country they were from. The fact is a lot of people used it. The phrase was: “I’ll think about it.” A Binary Options trader needs to take action rather than wait and see and then react to the market. As a trader, you need to be quick. A sudden brain spasm spawned
by fear, doubt, or greed will most likely not bring consistently good results.
Hesitation is a trader’s enemy. That is the message in the guideline, “Plan
your trade, and then trade your plan.” Let me give you a few examples of when “I’ll think about it” happens. A binary options investor identifies a trade opportunity and looks to buy near a significant support level if prices decline to the planned entry area. The binary options trader establishes a risk factor based on a monetary loss or on a technical violation of a support level. Things are pretty good so far, as it seems the Binary Options trader has done the necessary homework. Now comes the time to place the trade. Ah, “I’ll think about it” pops into mind, and the trade is never entered. What happened? A lack of confidence in analytical ability, self-doubt that the trade will work, or fear that the trader’s pride will be hurt if the trade prediction does not work? Maybe the Binary Options trader is afraid of losing money or if the trade is a loser, a humiliating experience. So, the binary options trader decides to wait a few minutes to watch the market. You know that if the trade had worked out as planned, the four famous words
“I’ll think about it” would be forgotten. What fearful traders do think and
say is, “I should have done that” or “I knew that was going to be a winner”
or, better yet, “Boy, I don’t know what got into me. That would have been a
great trade.” Remember the “plan your trade, trade your plan” axiom? Even if a trade
does not work out, isn’t it better to take a risk and fail than to never take a
risk at all? After all, not every trade will be a winner. That is why you are—
or should be—using risk capital when trading. If you took a poll of investors, binary options traders, brokers, and retail customers and asked them, “What does it take to be a successful trader?” what
do you think the answer would be? Timing. Pure and simple, timing. Timing
your trade entries. So do your homework, plan your trade, and execute that plan by entering your orders. If the trade does not work out, examine what the results were so you can learn from the experience. Here’s a trading thought to share with you: “It’s okay to lose your shirt
in this business, just don’t lose your pants because that is where your wallet
is.” In other words, it is okay to lose, but don’t lose everything because then
you have no equity to come back with. Losses need to be minimized and examined. Study what went wrong and use your findings as experience for the
next trade. As Jesse Livermore and other famous traders have observed, you are
out of the game if your stake is gone. Don’t lose it all in one shot. That is
where money management techniques can prove to be vital for your survival
in this game. That applies to both losers and winners. Profits need to be
taken. If you believe in managing risks, you need to manage profits, too, because the markets give and they definitely take away.
One question that new binary options traders ask a lot is, “Why do I do better at
paper trading than I do when I trade with real money?” The answer is easy.
Fear, doubt, complacency, greed, anxiety, excitement, and false pride can
all interfere with rational and intellectual thoughts. When dealing with real
money, you are faced with the realization that you and your money can actually be separated. Try not to get into the buyer’s remorse syndrome. That’s when you buy
a specific product and are still price shopping six months later to make absolutely sure that you got the best deal in town. That is another situation that creates negative emotions and you need to guard against it. Most binary options traders know the saying, “Any profit is a good profit, no matter how small.” It is hard for binary options traders not to look back, but you always have to think positive and be grateful that you picked the right market and did make some money. You should also feel confident and comfortable knowing that your system, method, or
skills may allow you the opportunity to do it again. A hindsight binary option trading is easy; being a mature, professional, and optimistic binary options trader is hard. Take a look at the market from a distance on the sidelines. Some binary options traders like to watch and wait; others will hope things change. The better or more experienced trader will simply get out. Sometimes this simple approach will save you from losses and give you a better time to reenter the market. Maybe you can identify with problems such as “Greed and the undisciplined trader” or “I’m-scared-so-I’ll-think-about-it trader.” I associate greed with the trader or investor who desperately wants to trade to make a quick buck. This type of trader personality profile is certain to realize failure when trading. Such traders have no discipline, acting on any rumor, story, or so called hot tip. They are checking research web sites and jumping from one
source to another to search for the winning trade. There is a common denominator with this type of binary options trader: They constantly do the same thing over and over and over again, generally resulting in losses.
There is an old definition for insanity: repeating the same actions and expecting a different outcome each time.