in a short time?
Despite the notoriety associated with trading breakouts, it remains one of the most
basic concepts in trading. A breakout typically occurs when the currency price
moves beyond a period of consolidation or trading range, or when the price
penetrates above or below an established price level, which can be a resistance or
support level, resulting in a follow-through of prices past those levels, whether
temporarily or permanently. The price movement past a breakout point can either
be a short or a more sustained affair, and that may depend on the time frame of
prices that you are looking at.
Even though big market players tend to fade breakouts, and it is better for retail
traders to side with these players, it does not mean that trading breakouts is entirely
a bad idea. Breakout trading does have merits, and a different set of rules as
compared to fading breakouts.
It is better to first assume that any breakout from a significant level is false, as false breakouts are more common than successful breakouts. However, there are times when trading breakouts can be very
profitable, even though breakouts are known to be technically unstable. Hence, in
order to trade breakouts with a higher probability of success, you have to
incorporate as many market factors as possible, including both technical and
fundamental analysis, to get a better feel of the current overall market sentiment.
The problem of lack of volume data
While volume is critical to the trading of breakout in other asset classes like stocks
or futures, in the forex market traders lack the knowledge of volume since there is
no central exchange to monitor all the transactions that have gone through or are
going through. Lack of forex volume data is a huge disadvantage to forex traders
as volume often reveals where the market is positioned or is positioning, and is
often an important criteria of any breakout trading strategies as successful
breakouts are generally accompanied by a rise in volume. In view of that, you have
to rely on several guidelines so that you can position yourself for a potentially
good breakout.
Types of Breakouts
When a price attempts a breakout of a significant support or resistance level, it
signals a change in the balance of supply and demand, and such a change may be
triggered by a change in market sentiment, or a renewed resolution of bulls or bears
of a currency pair, or the unfolding of certain fundamental events. Successful
breakouts must be accompanied with a strong surge of momentum in the direction
of the price breakout.
Price breakouts can be categorised into two main types:
1. continuation breakouts, and
2. reversal breakouts.
According to the basic tenet of technical analysis, one should always assume the
underlying trend to continue unless proved otherwise, and it is no exception in
this case.
Continuation breakout
In a continuation breakout, currency prices break out of established price levels to
resume the underlying trend, by climbing higher in a continuation of an uptrend, or
by falling lower in a downtrend. Usually, a breakout occurs after a period of
consolidation in which when buyers and sellers of a currency pair regroup and
contemplate the next price move.
Reversal breakout
Sometimes, a current trend may be near its last stage, and could be in the process
of reversing as the hype fuelling the trend is extinguished. In such a situation, a
breakout could lead to a trend reversal and the beginning of a new trend, hence it
being a reversal breakout.
False breakouts
However, there are many times when prices do not move in a straightforward
direction (whether continuation or reversal) in the real trading world. Traders
observing a price breakout could be treated to a display of the infamous false
breakout which all breakout traders fear and detest. A false breakout occurs when
the price has pierced through the support or resistance level, but then retreats back
into the previous price zone, thus stopping out most breakout traders if their stops
are just below the support or above the resistance level. Institutional players are
often the culprits behind false breakouts as they manipulate the currency price past
common stop levels so as to deliberately clean out that side of the market.
The worst kind of breakout is the whipsaw type, whereby prices move out of the
price range, then back into the range, and then break out of the level again, stopping
both breakout traders and faders at least once (See Figure 8.3).Awhipsaw breakout
usually occurs when there is lack of momentum behind the price move or when the
breakout is small and weak. What makes a breakout unsustainable is the lack of
subsequent waves of buyers or sellers of a currency pair to generate more buying
or selling interest in an upside or downside breakout respectively after the first
wave of buyers or sellers has jumped in shortly after the breakout. Sometimes, the
price action can be so choppy that it is better to stay out of the market.
With so many different outcomes of a breakout, all breakouts must be treated with
some degree of suspicion, even if you have iron-clad reasons not to doubt the
direction of your trade, they all carry some risk of failure. That is when reasonably
placed stops can help preserve the rest of your capital when a price breakout does
not go your way.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets
