trade a breakout and when to trade against it. I know traders who only fade
breakouts, and also people from the camp that only trade breakouts. In the forex
trading business, good traders cannot afford to be rigid in their mindset and follow
laid out for fading breakouts, should be just that – guidelines, not definite rules
carved in stone. Even though the general rule of thumb is to fade breakouts on the
first attempt, you need to take into consideration the various circumstances that
present optimal or less than ideal fading opportunities.
Adopt the Breakout Fading Strategy only when you sense a high probability of the
market situation supporting it. Not only must you spot a good location to carry out
this strategy, perfect timing is also a key ingredient to spotting an ideal fading
opportunity. From my experience, the best market condition for fading breakouts is
a range-bound market.
Range-bound markets
It is common knowledge that financial markets spend most of their time bouncing
back and forth between a range of prices trapped between a support and resistance
level, instead of always making fresh higher highs or lower lows in an uptrend or
downtrend. The forex market is no exception, and tends to stay range-bound most
of the time, in between trending phases.
Fading breakouts can be a very profitable trading strategy when the market is
ranging. A range is bound by a support level and a resistance level which are in
close proximity to each other, as buyers and sellers of a currency pair battle it out
after either side has established an extreme overbought or oversold price zone. This
period of consolidation settles the currency prices within a range, and may be
manifested in the form of a rectangle (a horizontal channel) or a triangle, whereby
neither bulls nor bears of a currency pair are stronger than the other. At some point,
either the bulls or the bears will wrestle control and overpower the other party,
marking the start of a trending phase again.
A trading range should consist of at least two contact points at the support and at
the resistance levels drawn. It is preferable to fade breakouts at the third or even
fourth contact points at these levels on the hourly or daily charts as they tend to be
more reliable. Fading breakouts in a rectangle or triangle involves
buying at the support line and selling at the resistance line at the third or fourth
contact point on either side, unless there are overwhelming signs that the market is
ready to trend again.
The Breakout Fading Strategy tends not to work as well for strong trending phases
of the market, and is more effective in range-bound market conditions. That said,
you can still fade a breakout while in a strong trend, if you can contend with a very
small profit objective of not more than 20-30 pips. So whether or not you fade a
breakout during a trending phase really depends on your own preference, degree of
risk appetite and experience in the market.
There are times when it is better to follow the crowd, and there are times when we
should deviate from it. The Breakout Fading Strategy requires the trader to think of
what the crowd would do in the given situation based on the chart or price patterns
and market conditions, and then act the opposite way of what the crowd would do.
For the independent trader to have success on his or her side, he or she must think
like the big institutional players, and stick to what these players are likely to do.
From my experience trading the forex market, I think it is better to be skeptical of
any first breakout attempt from a significant level.While not every breakout fading
trade will turn out profitable, knowing how to identify high probability entries can
improve your odds of success when trading this strategy.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets
