By
David Dombrowsky

How to Trade Breakouts

Published on
July 26, 2023

In this article, we learn about breakout trading strategies, how to identify real breakouts when trading Forex, and how to identify false breakouts, downsizing your risk. We'll also walk you through how to react instead of predicting the start of new trends and trade consolidations and deal with sudden market reversals.

You can enter excellent trades using the right strategy and technical analysis when the market is trending in the right direction. But markets aren't always conducive and will range, move sideways, and trend in opposite directions. If you don’t have the best approach, technique, or strategy, it can be challenging to leverage trading opportunities.

When done right, breakout trading is captivating since you can make quick profits, but it has risks. False breakouts or whipsaws that aren't accompanied by increased volatility are common, and price levels may not be sustainable.


What Is Breakout Trading, and What's the Best Time to Use It as a Strategy?

If you can predict that the market direction will lead to a new trend and identify when to consolidate ranges or enter sideways, you're essentially breakout trading. That's done by analyzing the market's movement to determine that it's not biased but moves within upper resistance and lower support levels.

Once you’ve identified that the market moves a range that’s either trending or non-trending, you'll look at the trend history to find failure highs or rebound lows. If the market breaks out below support levels, enter short positions and buy long exposures above resistance in favorable trading ranges.


15-minute downtrend indicating price fluctuations before the breakout.

Source: hmarkets.com 


In such a breakout, setting a stop loss on top of the identified resistance for a short breakout and below the defined support level when buying long is essential. It’s also advisable to place a buffer or price filter above or below the placed stop, whether for resistance or support levels.

A technical momentum indicator is useful in timing your breakout entry and identifying resistance or support levels at which it occurs. Always find a market trapped between a range pattern, such as a channel or triangle, and wait until it breaks beyond the volatility surges.

You'll avoid predicting the market but react to it and buy high and sell low as a form of momentum trading. That means you'll enter when resistance levels fail or break out above it and sell when below support since, with breakout trading, you're seeking to profit from increased volatility.


What Are the Tips for Trading Breakouts and Identifying False Breaks?

There are ways to trade breakouts and others that will frustrate you as an FX trader, especially if you’re used to targeting trading opportunities in well-defined price ranges. That’s because you should be aware of false breaks and patterns or ranges occurring within significant trends.


Price movements and confirmation candle indicating volatility

Source: tolberti.com 


When you wait for breakouts, you should focus on patterns like pennants, flags, and triangles. To set the groundwork for your breakout trading, follow these tips that include;


Confirm a Breakout by Waiting for Volatility vs. Higher Volume

Unlike futures or stocks, the Forex market doesn't rely on the volume of trades, and you're at a disadvantage when managing risk. To position for a potential breakout, identify price movements at short time frames that signal high volatility.

Entering the market when movement is speedy is stressful and comes with anxiety, so you must use volatility to your advantage. Find currency pairs when volatility is low, so you'll be in a stellar position when it skyrockets, and a breakout occurs.


Increase momentum before the breakout.

Source: tradeciety.com


Trade a Breakout in the Trend's Direction

Stick to breakouts that follow the general direction of a prevailing trend, using technical analysis tools to study patterns like rectangles, triangles, and wedges. You can boil this down with the simplicity of focusing on two swing points that allow drawing support and resistance lines against the trend.

As a form of trend trading, breakouts offer an elaborate way to join after a pullback, but it's best to place a pending order in many instances. That's because a stop loss for selling below the support level might lead to a loss as it triggers your entry as the price returns to a high.

Avoid a false breakout by placing entry orders below the breakout candle for short positions, especially if the candle's length exceeds the 1.5 pip average. Whether a pin bar or doji, the second confirmation candle should be smaller and close below the breakout level.


Example of Breakout Trades

Breakout trading is often based on consolidating formation, and price triangles or channels project your natural target. Since you're following trends on a volatile market, keep in mind that it may break out swiftly and snap back as quickly, so set actual limit orders.


False Breakout or Fake Out

An unsuccessful or false breakout will signal a currency pair’s move from a downtrend to a trading non-trend range. The market will pull back or rebound between resistance and support parameters and then push back to a fake bearish breakout, also called a fake out.

When you use a time or price filter, you can avoid a short breakout position when the market doesn't continue lower or reverts to its trading range quickly.


Moving average indicator showing shifting momentum at breakout

Source: tradeciety.com 


A Real or Successful Breakout

In a successful trend trading breakout, the currency pair continues within the range with stall-back moves from below resistance and down rebounds above support levels. When the market signals a break from the bullish range, it's categorized as an impulsive or aggressive higher move.

That would be a successful breakout from a sideways trading range as the currency pair significantly climbed higher.


Benefits and Downsides of Breakout Trading

The best way to save time is by scanning for candidates for potential breakouts using trend trading and technical analysis scanners. Look for patterns on your FX charts, such as channels, flags, and wedges, or shortlist currency pairs that showcase low volatility with exponential moving averages or Bollinger bands.


Pros

Some benefits of breakout trading include leading to profitable solid trades when entered at the beginning of bearish or bullish trends. Rather than wait for a trend to establish, early entry allows you to incur significant profits when you identify the trading range with stop losses or exit levels.

You can define unsuccessful breakouts within your strategy to limit losses due to fake outs by setting tight stop losses.


Cons

On the other hand, fake breakouts may happen when the market breaks out below support and above resistance levels. That's common when no bearish or bullish trend is established or when the market reverts to its initial trading range.


Resistance and support level indications of breakout momentum

Source: tradeciety.com


Active risk management or stop losses are the only techniques to protect your trades from such occurrences. The market may also break out from range, but you need to move farther for your take profit target, seeing a move back risks before starting a new trend. That's when an active top loss pulls out your position before the trend energizes.


Final Word

You can combine essential price action and trend trading skills to approach a breakout without ignoring momentum due to the simplicity of this strategy. Retracement trades and bullish reversals occur from the significant accumulation and minor bull wedges in a crucial context that signals how to proceed.

The market will tell you whether the breakout is real or fake, especially if price movement flutters around tight ranges. Breakout trading can serve you well if done right and when you continually iterate on feedback and learn to improve on open opportunities. 


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