Binary Options Simple and Explained

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Candlestick Charts and Patterns

Candlestick charts are perhaps the most popular trading chart. With a wealth of data hidden within each candle, the patterns form the basis for many a trade or trading strategy.

Here we explain the candlestick and each element of the candle itself. Then we explain common candlestick patterns like the doji, hammer and gravestone. Beyond that, we explore some of the strategy, and chart analysis with short tutorials. Reading candlestick charts provides a solid foundation for technical analysis and winning binary options strategy.

Japanese Candlestick Charts Explained

Japanese Candlesticks are one of the most widely used chart types. The charts show a lot of information, and do so in a highly visual way, making it easy for traders to see potential trading signals or trends and perform analysis with greater speed. So let us explain what Japanese Candlesticks are, how the “candles” are created and basic candlestick interpretation.

It’s a fact that many novice traders, new to the trading industry, focus on candlesticks because they are easy to understand and give a feeling of real trading to someone. But it’s also a fact that nobody made money only using candlestick patterns. Many new traders are excited because they have some good results in the beginning by candlestick patterns without spending much time reading about trading, but in the long run they fail and they come back to learn more.

Candlestick patterns are a good tool, but only for confirmation. Of course every trader should know how to read the candles. I believe this is “Lesson #1” for the new traders. If you know how to read the candles properly, you can use them for confirmation in your trades – but first you must know the basics

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Candlestick Patterns

Japanese Candlesticks are a type of chart which shows the high, low, open and close of an assets price, as well as quickly showing whether the asset finished higher or lower over a specific period, by creating an easy to read, simple, interpretation of the market. Candlesticks can be used for all time frames – from a 1 minute chart right up to weekly and yearly charts, and have a long and rich history dating back to the feudal rice markets of ancient Samurai dominated Japan. When information is presented in such a way, it makes it relatively easy – compared to other forms of charts – to perform analysis and spot trade signals.

To understand how this works, we’ll need to look at how each bar is constructed. As indicated, each candle provides information on the open, close, high and low of an assets price. Each reflects the time period you have selected for your chart. For example, if a 5 minute chart was used each candle shows the open, close, high and low price information for a 5 minute period. When 5 minutes has elapsed a new 5 minute candle starts.

The same process occurs whether you use a 1 minute chart or a weekly chart.The open and close are marked by the “fat” part of the candlestick. This is called the real body, and represents the difference between the open and close. If the close is higher than the open, the candle will be green or white; if the close is lower than open the bar will be red or black but other colors can often be found on different charts.

The open or close are not necessarily the high or low price points of the period though. The high and low prices for the period are marked by a “wick” or “upper shadow” and “lower shadow.” The high point of the upper shadow gives the highest price the asset went during that period, and the low point of the lower shadow gives the lowest price the asset went during that period.

If there are no upper or lower shadow it means the open and close were also the high and low for that period which in itself is a kind of signal of market strength and direction. Occasionally you will also see bars that are nearly all upper and/or lower shadow, with very little real body. These are called dojis and have special meaning, a market in balance, and often give strong signals.

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Strategy Basics

Due to the highly visual construction of candlesticks there are many signals and patterns which traders use for analysis and to establish trades. Some patterns will be classed as ‘advanced strategies’, but there are general principles that those new to Japanese Candlestick charts should understand. Here are a few, I’ll go into more detail on some of these ideas further along in this discussion.

  • A long real body indicates stronger pressure than a small real body. For example, a long green body represents stronger buying pressure than a small green body. A long red body represents stronger selling pressure than a small red body.
  • Shadows can be used to determine what group of traders–buyers or sellers–was strongest at the close of a candle. While not always, it is quite possible that the strongest group at the close of the prior bar will be strongest heading into the next bar.
  • A long lower shadow with very little upper shadow indicates sellers tried to push the price down, but ultimately the buyers succeeded in pushing the price back up and were strong at the close.
  • A long upper shadow with very little lower shadow indicates buyers tried to push the price up, but ultimately the sellers succeeded in pushing the price back down and were strong at the close.

Interpreting Tails

What many traders fail to pay attention to is the tails or wicks of a candle. They mark the highs and lows in price which occurred over the price period, and show where the price closed in relation to the high and low. During an average day of trading upper and lower shadows are commonly formed, and they don’t really mean that much. But on some days, as when the price is trading near support or resistance levels, or along a trend line, or during a news event, a strong shadow may form and create a trading signal of real importance.

If there is one thing that everyone should remember about the candle wicks, shadows and tails is that they are fantastic indications of support, resistance and potential turning points in the market. To illustrate this point lets look at two very specific candle signals that incorporate long upper or lower shadows.

The Hammer

The hammer is a candle that has a long lower tail and a small body near the top of the candle. It shows that during that period (whether 1 minute, 5 minute or daily candlesticks) that price opened and fell quite a distance, but rallied back to close near (above or below) the open. This is sign that buyers stepped into a weak market and are “hammering out a bottom.”

Long lower tails are seen all over the place, and aren’t significant on their own. But they are significant when a long lower tail–hammer–is seen near support. It indicates the sellers tried to push the price through support but failed, and now the buyers are likely to take price higher again. The thing to remember here is that a hammer could indicate a new area of support as well.

Figure 1 shows an example of a hammer candle on the USDJPY Daily Chart.

Three candles, all with long tails occurred in the same price area and had very similar price lows. That three long tailed candles all respected the same area showed there was strong support at 100.800. When the hammer occurred (third candle in the series with the red area below it) it showed that price was likely to continue higher, since sellers had tried to push the price lower, but couldn’t.

The Gravestone

The gravestone (or ‘tombstone’) is a candle that has a long upper tail and a small body near the bottom of the candle, opposite of the hammer. It shows that during the period (whether 1 minute, 5 minute or daily candlesticks) that price opened then rallied quite a distance, but then fell to close near (above or below) the open. This is sign that sellers stepped into a hot market and created a graveyard for the buyers.

Long upper tails are seen all over the place, and are not significant on their own. But they are significant when a long upper tail–gravestone–is seen near resistance, unless of course a new resistance level is being set. It indicates the buyers tried to push the price through resistance but failed, and now the sellers are likely to take price lower again.

Figure 2 shows an example of a gravestone candle on the EURUSD hourly chart.

The price tested this resistance area multiple times, finally it broke above it, but within the same bar (one hour) the price collapsed back. This indicated the buyers didn’t have control and that the breakout would likely fail. The price did proceed lower from there.

Tails, Wicks And Shadows

Look for them on candles, they are important. Multiple long tails in one area, like in figure 1, show there is a support or resistance there. If a hammer or gravestone candle occurs near support or resistance, expect a reversal since the support/resistance has held. A hammer opens and closes near the top of the candle, and has a long lower tail. A gravestone opens and closes near the bottom of the candle, and has a long upper tail. By themselves they can give shady signals so beware, when used with other analysis like support/resistance, stochastic, MACD, trend line etc are a very powerful tool of the modern trader. The next thing to look out for is the doji, a candle that combines traits of the hammer and gravestone into one powerful signal.

Doji Strategy for Binary Options

Dojis are among the most powerful candlestick signals, if you are not using them you should be. Candlesticks are by far the best method of charting for binary options and of the many signals derived from candlestick charting dojis are among the most popular and easy to spot.

There are several types of dojis to be aware of but they all share a few common traits. First, they are candles with little to no visible body, that is, the open and closing price of that sessions trading are equal or very, very close together. Dojis also tend to have pronounced shadows, either upper or lower or both. These traits combine to give deep insight into the market and can show times of balance as well as extremes. In terms of signals they are pretty accurate at pinpointing market reversals, provided you read them correctly.

Like all signals, doji candles can appear at any time for just about any reason. All they really signify is a balance of today’s traders; if buyers and sellers are in balance during a session price action will remain stable. It takes other factors to give the doji true importance such as volume, size and position relative to technical price levels. Truly important dojis are rarer than most candle signals but also more reliable to trade on. Here are some things to consider.

First, how big is the doji. If it is relatively small, as in it has short upper and lower shadows, it may be nothing more than a spinning top style candle and representative of a drifting market and one without direction. If however the doji shadows encompass a range larger than normal the strength of the signal increases, and increases relative to the size of the doji. Candles with extremely large shadows are called long legged dojis and are the strongest of all doji signals.

Second is where the doji appears; does it appear at a support or resistance line or is it floating in a no man’s land between two support/resistance targets. If it is not near a support/resistance line the signal is much weaker than if it is confirming a support or resistance. In fact, if the shadow, either upper or lower, crosses one of these lines and then closes above/below it the signal is quite strong indeed.

One of this type appearing at support may be a shooting star, pin bar or hanging man signal; one occurring at support may be a tombstone or a hammer signal. Look at the example below. There are numerous candles that fit the basic definition of a doji but only one stands out as a valid signal. This doji is long legged, appears at support and closes above that support level.

Another confirming indication that a doji is a strong signal and not a fake one is volume. The higher the volume the better as it is an indication of market commitment. In respect to the above example it means that price has corrected to an extreme, and at that extreme buyers stepped in. It also means that near term sellers have disappeared, or all those who wanted to sell are now out of the market, leaving the road clear for bullish price action.

Doji’s can be trend following or indicate reversals so that must be considered as well. A doji confirming support during a clear uptrend is a trend following signal while one occurring at a peak during the same trend may indicate a correction. The same is true for down trends. Failing to account for trend, or range bound conditions, can be the difference between a profitable entry or not.

Breakout Strategy – Setup A Robot

The below demo video, explains how to configure a robot using the builder feature at IQ Option. The video explain how to specifically setup a strategy based on candlesticks, and doji patterns within them;

Doji Patterns – Conclusions

While doji’s can be fantastic signals for binary options they should be considered a signal to look for entry, and not as an entry itself. In the example above a call option is clearly the correct thing to do but if purchased at the close of the doji, it could easily have resulted in a loss. The doji shows support like sonar shows the bottom of the ocean but that does not mean a reversal will happen immediately. The best thing to do is to wait for at least the next candle and target an entry close to support. This same is true for resistance as well.

Doji’s are also fine to use in any time frame but remember the rules. When changing time frames add this; the doji’s size and analysis is relative to other doji’s and candles in that time frame. A long legged doji doesn’t mean the same thing if they appear frequently on the charts unless it is significantly larger the average long legged doji.

Expiry will be your final concern. If entry is taken very close to the targeted support/resistance level a one or two bar expiry is most likely all you will need but it may be prudent to extend that out to 5 bars just to make sure.

Chart Patterns Explained

Have you ever heard the saying, “can’t see the forest for the trees”? This is a very apt saying that simply means getting caught up in the small things and not seeing the bigger picture. This can happen all to often when trading and is especially common among newer traders. This can happen in a number of ways such as too many indicators, paying too much attention to minor day to day fluctuations or in the case of today’s discussion, paying to much attention to your Japanese Candlesticks. Candlesticks, and candlestick charting, are one of the top methods of analyzing financial charts but like all indicators can provide just as many bad or false signals as it does good ones. For that reason alone it is a good idea to filter any candle signal with some other indicator or analysis.

I’m going to assume that you already know something about candles because you are this deep into the article already. I like them because they offer so much more insight into price action. Switching from a line chart to an O-H-L-C chart to a candlestick chart is like bringing the market into focus. The candles jump off the chart and scream things like Doji, Harami and other basic price patterns that can alter the course of the market. The thing is, these patterns can happen everyday. Which ones are the ones you want to use for your signals? That is the question on the mind of any one who has tried and failed to trade with this technique.

Candlestick Analysis – Examples

Look at the chart below; a new candle forms every day. Some day a bullish candle, some days a bearish one, some times two or more days combine to form a larger pattern. Not all of them result in the “expected” movement. Look at the chart below. I have marked 8 candle patterns widely used by traders that failed to perform as expected.

Why is this you may ask yourself? It all comes down to where the signals occur relative to past price action. When I start to add other indicators to the charts it may become clearer. The first and foremost reason is that the candle patterns I have marked do not take any other technical or fundamental factors into account. I know that as binary traders we do not use much fundamental analysis but any trader worth his salt has at least a minor grip on the underlying market conditions. After that some simple additions to the chart can help to give some perspective and allow you to see the forest, and not just the trees.

Time frame is one important factor when analyzing candlesticks. The very first thing I like to do is to literally take a step back from my standard chart for a better view of the market. I use charts of daily prices with 6 months or one year of data. To get the broadest view I can I use a chart with 5 or 10 years of data. The 5 year chart is where I draw support, resistance and trend lines that will have the most importance in my later analysis. Having an idea of where price action, and the candlesticks, are in relation to the long term trend and areas of support/resistance is crucial to interpretation. A candle signal occurring at or near a long term line is of far more value than one that is near a shorter term line. You can use weekly bars or daily, it doesn’t matter, but sometimes a really strong candle signal will appear on the weekly charts too.

Moving Averages

Moving averages are another good way to help weed out bad candlestick signals. There are many types of moving averages but I like to use the exponential moving average because it tracks prices more closely than the simple moving average. I use the 30 bar and 150 bar moving averages but you can use any duration that works for you. The point is to use the EMA’s to help confirm or deny potential candle signals. In theory, each moving average represents a group of traders; the 30 day EMA short term traders and the 150 day EMA longer term traders. A candlestick signal that fires along the moving averages is a sign that that group of traders is behind the move. A signal along the 30 bar EMA would not be as strong as a signal along the 150 bar EMA while a signal that fired while the two EMA’s were tracking alongside each other would be the strongest of all.

Volume

Volume is a third factor that I like to take into consideration when analyzing candle charts. Volume is one of the most important drivers of an assets price. The more people that want to buy an asset the higher and quicker prices will move up. The more people that want to sell an asset the lower and quicker prices will drop. This can also be applied to candlesticks, the more volume during a given candle signal the more important of a signal it will be. Further, if volume rises on the second or third day of a signal that is additional sign that the signal is a good one.

Take a look at the chart below. I have redrawn support, resistance, trend lines and moving averages. Then I looked for candle signals along those lines and correlated volume spike to them. Using the additional analysis techniques the 8 losses on the chart above could have been avoided and instead been turned into these dozen or so winning trades. The volume does not spike on every signal but there are a few significant spikes to see.

Reading Charts – Closing Guide

There are many candlestick patterns for you to explore if you enjoy this type of “visual” trading style, I’ve barely scratched the surface. Candlestick patterns are useful for both short and long-term trades as these patterns occur on one minute charts right up to weekly charts (or longer). Looking at a chart you’ll see lots of patterns, the key is to understand which ones are really signals and which ones are just random market movements. Be selective, and only trade when there are confirming factors and indicators. Use other technical analysis methods to validate all patterns. For example, a bullish engulfing pattern that occurs at a support level is more likely to work out than if a bullish engulfing pattern occurs on its own

Binary Option

What is a Binary Option?

A binary option is a financial product where the buyer receives a payout or loses their investment, based on if the option expires in the money. Binary options depend on the outcome of a “yes or no” proposition, hence the name “binary.” Binary options have an expiry date and/or time. At the time of expiry, the price of the underlying asset must be on the correct side of the strike price (based on the trade taken) for the trader to make a profit.

A binary option automatically exercises, meaning the gain or loss on the trade is automatically credited or debited to the trader’s account when the option expires.

Binary Options Outside the US

Basics of a Binary Option

A binary option may be as simple as whether the share price of ABC will be above $25 on April 22, 2020, at 10:45 a.m. The trader makes a decision, either yes (it will be higher) or no (it will be lower).

Let’s say the trader thinks the price will be trading above $25, on that date and time, and is willing to bet $100 on it. If ABC shares trade above $25 at that date and time, the trader receives a payout per the terms agreed. For example, if the payout was 70%, the binary broker credits the trader’s account with $70.

If the price trades below $25 at that date and time, the trader was wrong and loses their $100 investment in the trade.

Key Takeaways

  • Binary options depend on the outcome of a “yes or no” proposition.
  • Traders receive a payout if the binary option expires in the money and incur a loss if it expires out of the money.
  • Binary options set a fixed payout and loss amount.
  • Binary options don’t allow traders to take a position in the underlying security.
  • Most binary options trading occurs outside the United States.

Difference Between Binary and Vanilla Options

A vanilla American option gives the holder the right to buy or sell an underlying asset at a specified price before the expiration date of the option. A European option is the same, except traders can only exercise that right on the expiration date. Vanilla options, or just “options,” provide the buyer with potential ownership of the underlying asset. When buying these options, traders have fixed risk, but profits vary depending on how far the price of the underlying asset moves.

Binary options differ in that they don’t provide the possibility of taking a position in the underlying asset. Binary options typically specify a fixed maximum payout, while maximum risk is limited to the amount invested in the option. Movement in the underlying asset doesn’t affect the payout received or loss incurred.

The profit or loss depends on whether the price of the underlying is on the correct side of the strike price. Some binary options can be closed before expiration, although this typically reduces the payout received (if the option is in the money).

Binary Options and Regulation

Binary options occasionally trade on platforms regulated by the Securities and Exchange Commission (SEC) and other regulatory agencies, but most binary options trading occurs outside the United States and may not be regulated. Unregulated binary options brokers don’t have to meet a particular standard; therefore, investors should be wary of the potential for fraud. Conversely, vanilla options trade on regulated U.S. exchanges and are subject to greater oversight.

Real World Binary Options Example

Nadex is a regulated binary options exchange in the United States. Nadex binary options are based on a “yes or no” proposition and allow traders to exit before expiry. The binary option’s entry price indicates the potential profit or loss, with all options expiring worth $100 or $0.

Let’s assume stock Colgate-Palmolive Co. (CL) is currently trading at $64.75. A binary option has a strike price of $65 and expires tomorrow at 12 p.m. The trader can buy the option for $40. If the price of the stock finishes above $65, the option expires in the money and is worth $100. The trader makes $60 ($100 – $40).

If the option expires and the price of the Colgate is below $65 (out of the money), the trader loses the $40 they put into the option. The potential profit and loss, combined, always equals $100 with a Nadex binary option.

If the trader wanted to make a more significant investment, he or she could change the number of options traded. For example, selecting three contracts, in this case, would up the risk to $120, and increase the profit potential to $180.

Non-Nadex binary options are similar, except they typically aren’t regulated in the United States, often can’t be exited before expiry, usually have fixed percentage payout for wins (whereas Nadex payouts fluctuate based on the price paid for the option) and may not trade in $100 increments.

Binary Option Explained

Before anyone can consider trading Binary Options, they have to have an understanding of the fundamentals behind the options including how they work and how they differ from traditional options. In other words, a binary option explained in simple terms.

Binary Options have often been touted as “easy” ways to make money. This may indeed seem slightly disingenuous. This is because only those who have an understanding of options can make money.

Binary Options are also often misunderstood as an instrument. They are thought of as taken mere “bets” on the underlying instrument. Although practically correct, the technicality behind it is not quite as clear cut.

In this post we will go through some of the basics of Binary Options so that when you are ready to trade the instruments you have a better grasp of various factors will impact on the binary option.

What is an Option?

Before we can look at the fundamentals behind Binary Options, we have to cover the concept of financial options and what they are exactly.

A financial Option is a derivative instrument. In other words, it is a financial instrument that gets its value from the price of some other asset. Hence the value of an option is “derived” from an asset such as a share, forex or commodity.

In essence, an option allows the holder the right but not the obligation to buy / sell the underlying asset from the option seller at a predetermined time (T) and price (x). The expiry time (t) and the price (x) are both very important inputs in the Binary Option price.

There are two types of financial options. They are the CALL and the PUT option. A CALL option gives the holder the right to buy the underlying asset at the strike price on the expiry. The PUT option gives the holder the right to sell the underlying asset.

The goal of the option trader is to exercise the option and buy/sell the asset if the price is above the strike/below the strike in the case of the CALL/PUT option. This will yield the trader the profit which is the difference between the prevailing price and the strike (less the option price).

However, most option traders don’t tend to exercise the option and prefer to receive the payout from the option seller. The theory behind trading traditional vanilla options can be quite complex and is hence is mostly traded on wall street with advanced “volatility” traders.

Things are, however, slightly different when it comes to Binary Options. Although they share some of the same option greeks technicalities, they can be traded in an easier fashion.

Explaining Binary Options

In mathematics, binary is the reference to one of two numbers, either 1 or 0. In a similar fashion, in statistical theory, a binary outcome is one in which there are only two outcomes.

This is why binary options are termed as such. Unlike traditional options, there are only two payouts with a binary option. They are either 1 (or 100) or zero. Hence the trader will either get the payout value or will lose their initial investment.

This is why Binary Options are often thought about as “bets”. Hence, if the option expires in the money (ITM) the trader knows the exact amount that they will be getting. The same is said when the option expires out of the money.

This difference between traditional options and Binary Options is better explained with a graph. As one can see in the graph to the right the payoff profile of a Binary Option as compared to a traditional option.

These options are still considered exotic instruments at global investment banks as Over the Counter (OTC) instruments. They are also generally quite hard to price given their binary payoff.

However, they have taken on a life of their own in the retail binary options market. The original binary option instrument is seen as a simple Up or Down investment. In other words the trader will either get paid if the option is above or below the entry point.

In order to explain binary options appropriately, we need to take a look at a few examples of binary option trades.

Example Binary Option Trades

When it comes to trading High/Low (Up/Down) binary options on an investment platform, the trading parameters are usually quite simplified and easy to select.

You will have to select the asset that you would like to trade as well as the expiry time, whether it will go up or down and payout rate. The payout rate is the amount in % that you will be paid out if the option expires in the money.

Taking a look at the below platform, we have the IQOption trading interface. As you can see, the trader can select the parameters that he favours and this will then impact the expiry price (x). In this case, the trader suspects that the price of gold will increase in the next 7 minutes.

In the above example, if the trader had decided to enter the Binary CALL option at the entry price then the expiry level is given by the current level. The trader also has a 75% payout ratio so if this option ends in the money then the trader will earn 75% of his investment ($75 in this case).

If, however, the option was to expire out of the money then the trader would get nothing and lose the initial investment. In this case the trade will be determined on the expiry which is 7 minutes from now.

Let us take a look at another example, in this case the trader suspects that EURUSD will decrease in the next 30 minutes. This would mean entering a Binary PUT option on EURUSD expiring in 32 minutes. In the case of this PUT option the payout ratio is 81% so the trader will get $81.

The higher payout ratio will mean that the entry point (expiry price) will be priced slightly more out of range. Hence, if EURUSD is below the expiry price at the end of the 30 minutes then the trader will get 81% of their investment.

Other Binary Options

Although a simple High / Low Binary Option was appealing to many traders, there were quite a few who wanted to implement a range of strategies on Binary Options. As a result, Binary Option brokers decided to offer a number of more interesting Binary Option types.

Touch / No Touch Options

These are a particular type of Binary Option where the trader gets a large payout if the price of an asset touches / does not touch a particular level. They are a particular variant of traditional vanilla knock in options.

These are an interesting type of Binary Option for those who want a really large payout ratio (usually over 100%). They are also generally quite risky as the touch / no touch barrier is usually set quite far away from traditional High Low expiry levels.

In the below image, we have an example of a one touch trade on ETX Capital’s platform. In this one touch AUD/USD option, the trader is taking the view that the price will touch 0.75997 level before expiry of the option (44 minutes time)

If the option does indeed touch this upper level then the trader will receive 100% return on the investment and the payout will be $200.

With some brokers, the client has the option to set the level of the touch / no touch. The further away from the strike that the client moves, the larger the payout amount.

One Touch options are a good investment if the trader is trying to take advantage of high volatility or a lack thereof in the markets. It is also not an option type that a new trader should not really consider investing in.

Barrier Options

A barrier option is just a combination of two touch / no touch options. The trader takes the view that the option will remain either within or out of an upper and lower barrier. This is also sometimes called a “tunnel” option.

The payoff of the barrier option can either be bigger or smaller than the Touch / No Touch option. For example, if you enter a touch tunnel trade the payoff can be slightly less as there is more chance that it could either breach above or below.

On the other hand if you enter a no-touch tunnel trade then the payoff can be much larger. This is because the chances of the option not breaching the upper or lower limit is much less.

Taking a look at the 24Option platform screenshot below, we can see the setup for a EURUSD tunnel trade. The upper boundary of the tunnel is 1.3710 and the lower is 1.3706. If the trader had a view that EURUSD would end up between the two boundaries for the next 5 minutes then they would enter into a “in” boundary trade.

If the trade remained between the two levels then this would be a trade that ended in the money with $170 being the payoff. The opposite can be said for a trade where the option would go out of the tunnel. The trader would then enter into an “out” tunnel trade.

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  • Binomo
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