Hello Traders, I’m Mani and I’m the writer of Trade 77 section, please follow me on twitter for further updates.
What is a breakout?
Breakout is a move beyond some prior significant level such as a round level or strong S/R areas. Breakouts could be used in swing trades and also for intraday and scalping. Depends on the method we are using, breakouts have got different profiles. I will show you some examples of these breakouts but before getting started I want to classify breakouts in two groups:
- Suspect Breakouts
- Legitimate Breakouts
Suspect and Legitimate Breakouts Specifications:
- Breaking with low volume:
Volume is one of the most important points for considering a breakout as false or true one. So many traders have asked me about how to determine volume in the Forex market and here I want to say another categorical “NO” to indicators; I don’t use any indicators such as CCI, ATR or Bollinger Bands or so. The only thing I use here is “Price Action”.
Let’s see daily chart of EURUSD here for better perception:
If you see this figure you can easily find out when we had got low volume and when we had high volume. So when you are trading the daily chart and you are waiting for a possible breakout then 80pips range or even 100pips range bars could not enough for a possible legitimate breakout and you should wait for above 150 or 200pips range bars in order to consider it a true breakout.
Do not trust breakouts when market is in range; when we have low volume then market goes sideways and in these cases it won’t act good to technical levels and price patterns.
- Incorrect market timing:
Market timing is one the best filters that you should apply into your breakout methods. This is not seperated with the volume filtering even it is a way to determine low volume and high volume price actions.
Asian session and late on NY session (after 15:00 NY time) is the period of false breakouts. Do not trust breakouts in that period of time.
In the other hand in the London session and early NY session you can be more confident of breakouts.
- Unimportant levels:
Breakout of unimportant levels is not a good trading signal and many traders do this fault everyday.
Important levels can be found easily; More touches of a level, more important that level tends to be.
- Importance of the closing price:
Impatient traders won’t comfortable to wait and will trade whenever price breached that significant point. Always beware of head fakes and long tails which are indication of price wanted to attack that level again and will reject sharply with a long shadow. Wait for candles to close above or below that level before considering a breakout has taken place.
- Amount of time spent in the consolidation phase:
Before important breakouts we should have a very tight range which is called “consolidation phase”.
The longer the amount of time spent in the consolidation phase, the stronger the breakout tends to be.
In the figure above you can see Cable had a consolidation phase for almost 10days this was an indication of an important level is there and a breakout would make more than 500pips in the direction of the breakout.
Other Notes and methods:
- Two candle closes method:
Many traders will wait for a confirmation after a breakout formed, their confirmation is to wait for two candles that close completely below or above that level. This filter is a great tool to find suspect breakouts.
- Finding breakouts sooner:
When you are trading trendline breakouts you should apply two things:
a) More touches of a trendline and more important that trendline would be.
b) Finding sooner breakouts by drawing steeper trendlines.
In the figure above you can see a false breakout of trendline #1 but you could go long sooner at the breakout of trendline #2 which was the steeper trendline.
- Currency pairs profile:
It’s very important to have a good perception of the pair you are trading. GBP crosses love false breakouts as they like new fresh swing highs/lows. So you should beware of trading breakouts in these pairs and have to wait for more confirmations before taking positions.
- Trading the retest:
Patient traders usually will wait for the price to create a distance after breaking an important level and then will take positions when price went and did retest that significant level again.
In the figure above you can see this process, we had got a great breakout of that zone and price sharply increased and made a great distance to that zone. After that we had got a correction move and price did retest upper bond of that zone and indicates a great long setup.
- Using volume bars to have a better perception of volume:
You have got a volume indicator in your trading platform for sure and you can use them to find out high volume and low volume situations.
We can compare volume bars and with drawing a line we can find out the volume is increasing or decreasing.
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