June 25, 2018

Trading Options with Candlesticks

Bullish EngulfingStatistics show that over 80% of options traders lose money. Because of their very nature, stock options seem to stack the odds against the trader from the very start. Profiting in stock options requires the trader to correctly analyze and predict a future price move. Then the trader will have to successfully forecast the timeframe when that move is going to happen! Finally, the trader must also know how big that price move is going to be! The combination of these three factors makes it extremely difficult for the average trader to enter an option trade successfully.

So how can candlesticks turn these disadvantages onto advantages? When trading using candlesticks we find an answer to each of the elements that make up a successful option trade.

First is the price move itself. As a trader becomes more and more proficient with reading candlestick patterns they also become more accurate in determining changes in market direction. Candlestick reversal patterns have the unique ability to give us a visual snapshot of market psychology and when it is changing. Determining when this change takes place gives the candlestick trader an edge in entering a successful trade, either by entering an established trend or an even more profitable change in market direction.

Second is forecasting the size of the price move. Option contracts are purchased by price levels. If the price moves above or below the purchased price level, depending on the type of contract purchased, your contract goes “into the money” and starts becoming more profitable as the stock price moves above or below that price level. The successful candlestick trader not only determines the strength of a reversal or continuation pattern but also couples it with a price target using the rules of price action. This allows the trader to exit his option trade with the highest profit possible.

The final consideration is the timeframe in which the price move will happen. This is where most option traders fail at making a profitable trade. Options have a time premium built into the price and this premium gets smaller as the contract gets closer to expiration. This makes the contract lose value with each passing day. The reality is that even if you correctly predict the price move and the size of the move you can still lose money! The successful candlestick analyst has an edge at knowing when a price move is likely to happen. A strong reversal pattern coupled with a point of technical support or resistance gives an extremely accurate signal that a move is going to happen and happen soon!

While this article is not written to suggest that anyone begin trading options, you can see how candlesticks and their signals are among the most successful methods to trade stock options. Candlestick theory gives the options trader a unique advantage in overcoming the most difficult aspects of successful options trading.