Sentiment Indicators - Renko, Price Break, Kagi, Point and Figure: What They Are and How to Use Them to Trade

Chapter 7. Price Break Charts and Option Trading

Price break charts can assist the trader in deriving option trading strategies and tactics. The option trader is essentially making a directional decision on the trade. He anticipates the move based on his evaluation of market conditions, and the strength of that evaluation will essentially determine the outcome. This is in contrast to the spot trader, who reacts to the action and tries to join a move. Since the proposed option trade is either a pattern or trend continuation trade or one that anticipates a reversal of the trend, price break charts can become a key tool in confirming the strength of that analysis. Additionally, once the anticipated direction is established, the trader needs to select the strike prices. Price break charts offer a methodology for choosing the strike price locations. This chapter will explore innovative uses of price break charts in option trading.

Selecting Direction with Price Break Charts

An option trader's first priority is to establish a direction for a trade. Being wrong on the underlying direction will reduce the probability of being in a winnable option trade. A trader can make this directional decision in many ways, but we will focus on price break charts as a useful tool for selecting direction. Tom DeMark, a noted leader in technical analysis, writes in his book, DeMark on Day Trading Options about rules for buying calls and puts.

Rule No. 1: Buy calls when the overall market is down; buy puts ...