The ability to read an options chart can make or break even those most seasoned investors. With patterns and candlesticks being foundations of successful trading, investors must know how to read an options chart. The market is often a tug and war between sellers and buyers. Candlesticks map out this battle. When you group these candlesticks, patterns appear. Patterns play a significant role in investing in a stock market, whether you’re participating in day trading, options trading, or swing trading.
Reading a stock options chart and looking for patterns help investors determine whether to implement a bearish or bullish options trading strategy.
What Is an Options Chart?
Trading options for a living is an excellent way for investors to increase their brokerage account. Options provide them the ability, but no obligation, to sell (put) or buy (call) a stock at a specific price with each contract controlling 100 shares of stock.
An options chart illustrates the overall feelings of investors worldwide. With so many moving pieces associated with options, investors must have the best information available to make the best trade.
Developing a stock options chart strategy allows investors to make money regardless of the market trading sideways, up, or down. However, they still need to watch options charts for resistance, support, and direction.
Reading Candlesticks on a Stock Options Chart
Candlestick patterns were originally developed in the 17th century by a rice trader from Japan named Munehisa Homma to gauge how the supply and demand of rice were affected by emotions. With many believing emotional trading moves markets, investors often use stock option charts to benefit from other investors’ fear or excitement.
Candlestick charts are easy to read, highly intuitive technical tools that combine data from various time frames into singular price bars. These price bars are more useful than simple lines connecting dots of closing prices and traditional open-high-low-close (OHLC) charts because they develop patterns predicting price directions.
Common Candlestick Patterns
As the name suggestions, a candlestick pattern looks like a series of candlesticks with some having wicks or upward shadows, and other displaying tails and resembling an upside-down candlestick. The body itself is called the candlestick. If the body is hallow (white or green in color), it has a closing price that is higher than the opening price, indicating pressure to buy. If the body is filled (black or red in color), it has an opening price that was higher than the closing price, indicating pressure to sell.
The top of a wick indicates the high of a stock’s value at a particular time with the bottom of the tail representing the low for the same stock. The stock’s open and close prices are shown at the point where the tail or wick meets the candlestick.
Here are some common candlestick patterns routinely working well in predicting price momentum and direction, each working in conjunction with price bars surrounding them to predict lower or higher prices. They focus on pattern outcomes, continuations, and reversals. Continuation patterns predict extensions of the current price direction while reversals predict changes in price direction.
They are, however, time-sensitive, only working within the time limitations (monthly, weekly, daily, or intraday) of the chart being viewed with their potency rapidly decreasing three to five bars once the pattern has been completed.
- Three Line Strike: Bullish – Bullish Pattern
This three-line strike pattern illustrates a downtrend of three filled (red or black) candles. Each bar has a lower low, closing around the intrabar low with the fourth bar opening even lower but reversing in a wide-range outside bar closing above the original candle of the series’ high. The opening point also represents the fourth bar’s low. Many experts accept this reversal pattern as predicting higher stock prices with an accuracy rate of 84%.
- Two Black Gapping: Bearish Continuation Pattern
This two black gapping pattern arrives after a significant topping of an uptrend and a gap down that brings two black bars with lower lows. A continuing decline is predicted with this pattern with even lower lows, maybe also triggering a broad-scale downtrend. Many experts accept this continuation pattern as predicting lower pricing with an accuracy rate of 68%.
- Three Black Crows: Bearish Reversal Pattern
This three black crows pattern begins at or close to an uptrend high with three black bars showing lower lows closing around intrabar lows. This reversal pattern predicts a continuing decline to even lower lows, maybe even triggering a broad-scale downtrend. The most bearish of this pattern begins at a new high point trapping buyers coming into momentum plays. Many experts accept this reversal pattern as predicting lower pricing with an accuracy rate of 78%.
- Evening Star: Bearish Reversal Pattern
This evening star pattern begins with a tall open bar that takes an uptrend to a new high with the market gapping higher with the next bar. New investors willing to buy fail to appear, resulting in a narrow range candlestick. The third bar with a gap down completes this pattern predicting a continuing decline to lower lows and maybe triggering a broad-scale downtrend. Many experts accept this reversal pattern as predicting lower pricing with an accuracy rate of 72%.
- Abandoned Baby: Bullish Reversal Pattern
This abandoned baby pattern shows up at a downtrend low following a series of closed candles that indicate lower lows. The following bar has a lower market gap, but new investors looking to sell don’t appear, resulting in a narrow range doji candlestick that has both opening and closing points occurring at the same price. The last bar with a bullish gap completes this pattern that predicts continuing recovery to even higher highs, maybe resulting in a broad-scale uptrend. Many experts accept this reversal pattern as predicting higher pricing with an accuracy rate of 70%.
Free Candlestick Charting Software
Many investors like using candlestick charts as stock option price charts because they are easy to read for new investors while providing a great deal of information for those with more experience. Below are free option chart software options used by many traders, especially those starting out or who are on a budget.
Targeted toward day traders with 1-15 minute timeframe options and thriving social media pages. Investors are able to set up alerts and can view multiple charts for comparison at the same time. TradingView starts with a freemium platform with the option to upgrade for investors wanting access to additional features.
Have the ability to create candlestick, line, and bar charts with StockCharts.com’s functional software featuring a basic interface. The software offers up to three years of data if you have a free account with a $14.95 upgrade available for access to additional data.
- Yahoo! Finance
Another software on the more straightforward side in terms of aesthetics and features, Yahoo! Finance does allow users to filter their charts based on various technical indicators, a feature that often proves very useful. Traders are able to see stock movements over five years while viewing several charts for comparison at the same time.
- Google Finance
As with most of Google’s products, they’ve upped the ante and produced a beautiful program to track a stock options chart with. While not quite as in-depth as StockToTrade, Google’s interface is still really easy to use, especially for investors already completely integrated into the Google suite and are comfortable using them.
An options chart software that has been around for a significant amount of time, BigCharts.com is trusted by many longtime investors for their stock option price charts needs. With data available from back to the mid-1970s, investors are provided lots of historical information on several long-term companies. The software allows traders to use several technical indicators along with various types of charts, including intraday charts available from 1-60 minutes, providing users with more flexibility when it comes to price movement assessment.
When using options charting software like FreeStockCharts.com, traders need to have a solid understanding of “real-time” as any data less than 15 minutes old is BATS data, or coming from only one source and not representing all exchange data. Experts caution against dismissing this software, though, as it does offer several handy features, including intraday charts along with weekly, monthly, and yearly options. Users have up to 80 technical indicators to filter their data, saving favorite options chart layouts as long as they are signed in and have an account.
Another software starting with a freemium platform with upgrade options ranging from free up to $34.90 per month depending on desired features. It offers a variety of chart types, and its free version includes three years of historical data.
An options chart is an important tool of the trade. Learning candlestick terminology and meanings, identifying patterns, and using a stock options chart can help investors make more profitable trades. Up your options trading strategy with Jeff Bishop’s “Option Profit Accelerator” and learn how you can double or triple your account balance in just one week.