How to avoid fake breakouts? One of our Elite CurrenSea followers asked me this question earlier in the week and as always I provided a lengthy reply.
It also provided me inspiration for this article because it’s a problem that many traders face. Trading breakouts sounds simple but quickly becomes complex when you trading them in real-time.
This article provides five key tips on how to trade breakout setups with more confidence and success. Let’s start. (The video of this article is at the very bottom/end of this post)
No trader can know for sure whether the breakout will turn into a false break and fail. As always, the market decides and speaks and we traders need to listen and follow – NOT the other way around.
Many traders fall into the trap of analyzing and predicting the Forex markets and then blaming the market for not following their plan. This is not how trading works.
You need to continuously establish the most likely path of least resistance, which acts as a road map for price. This requires regular updating and is not a fixed path.
Also, realize that breakout trade setups occur after chart patterns have appeared. It is crucial to learn and recognize all of the chart patterns, or at least the most common ones.
If you know for instance the details of a contracting triangle and how it is expected to build 5 waves (ABCDE), it will help you understand when to expect a valid breakout. Make sure to join our telegram group to see this method in action.
I measure the success of a breakout by simply monitoring the strength of the candle close. A strong candle close is when the candlestick closes near the high or low.
Here is how a candlestick close works together with a breakout setup:
Another sign of strength is also visible via the candle size. A larger candle indicates a strong breakout candle than a smaller candle, relative to the candles of that time frame. Although candle size is a factor to consider, I personally think the candle close is more important.
I love trading breakouts by zooming one time frame and waiting for a pullback and continuing to unfold. For instance, if the pattern is visible a 4 hour chart, then I would zoom into a 1 hour chart and look for a smaller pattern to occur on that time frame. Why?
Because when price makes a pattern after strongly breaking out, then price is indicating that it is not a false breakout. It is showing that price is in fact building a new correction after momentum. This is a continuation signal indicated by the market psychology of price.
The correction on the lower time frame should not last too long. Anything from I think 13 candles to 24 is fine. From 24 to 36 could be ok depending on the overall market structure.
If prices does not build a pattern after the breakout, then it is most likely reversing and moving in the opposite direction with lots of speed. In that case price is either building a false breakout or price has hit a major support and resistance level and its bouncing strongly. Either way, it’s good to stay out.
So remember these are the key steps:
With the ecs.SWAT method trading breakouts and breaks of breaks is actually much simpler then all of the manual work mentioned in this article. In the image below (figure 3) you can see that very clear and all 6 setups are shown (purple numbers). You can get the system for free if you trade under our IB with one of our supported broker.
The ecs.SWAT rules and indicators remove the insecurity and guess work that often traders face when trading pullbacks and breakouts. When do I enter? When do I close? Is it a good breakout?
All of these problems are solved when trading with the ecs.SWAT method because the system does the measurement for you.
The ecs.SWAT method also highly recommends using trend lines and moving averages. The moving average are the best tool for measuring the psychology of the market:
The trend lines are critical too because they help measure the chart pattern itself. Drawing support and resistance levels will help us identify the pattern. In fact, traders need to see hundreds of patterns before they can start to spot patterns subconsciously.
The Envelope indicator is also a delight to use because the support and resistance bands can be used as a bounce or breakout zone. A breakout is most likely occurring when candlesticks close above the band resistance or below the band support.
When using moving averages and trend lines (as mentioned in tip 4), it is a useful tactic to review the relationship of price action with the support or resistance (S&R) level. One aspect is mentioned in tip #2, which is that the candle close closes near the candle high or low.
Here are a few more vital parts:
Image: shows 6 breakout long setups which are indicated by the green boxes. All setups on the EUR/USD are valid according to ecs.SWAT rules and closed for profits. Chart is from 27 July to 3 August 2017.