Hello and welcome to another edition of the bulls vs the bears. Today we are going to learn how to profit from trading breakouts step by step. First I am going to let you in on a little secret. If you want to prosper as a forex trader, you need to stack in the odds in your favor. This is because you are not always to be 100% spot on with your trades However, with a solid to risk to reward ratio, you can still make healthy profits.
Sure, some of you are saying to yourself “You are not making any sense.” But you have to know how to spot a great trading opportunity. And when you do you take advantage of the opportunity through your trading plan. You did put together your trading plan. Did you? Anyways you can spot some of these great trading opportunities when trading breakouts. In today’s lesson we are going to look at some of the benefits of trading breakouts. I guess a burning question some of you are asking is:
What Are Forex Breakouts?
Well forex breakouts are situations which occur when price break outs of a key level, courtesy of either the bulls or the bears. A very close look at price behavior on the charts suggests that price tends to stick to specific levels. When price hits a key level only to do a 360, this illustrates the strength and resilience of that key level. Keep a close eye on when price returns to touch the key level again. It could spark a breakout or a major rejection.
There are times when price may hit the same level with gleeful regularity. When that happens you may find yourself saying”This level is as tough as a pit bull.” But price eventually wins over that key level once that key level caves in. That’s when the breakout commences. I can hear another person with another question asking:
Why Should We Trade Forex Breakouts?
Well forex breakouts present amazing trading opportunities.When breakouts occur they spark new price moves and trends. And when you spot a breakout, you’d do well to get in on the action to take advantage of a juicy trend. This is because a lot of these breakouts are sparked by momentum and so you’d do well to maximize these opportunities when they show up on the charts. And for this reason breakout trading is very popular among forex traders.
Another burning question I hear someone asking is:
At Which Key Levels Do Breakouts Occur?
Well breakouts are known to occur in the following:
- Support Or Resistance
- Time highs or lows
- Trend Lines
- Price Channels
- Moving Averages
- Chart Patterns
- Fibonacci Levels
- Pivot Points
Breakouts move prices so quickly because major players are watching these key levels like hawks. So when one side breaks through the losing side has to save face by covering their losing positions. It is this act of desperation that triggers the sharp price movements.
Now it is your job as traders to spot these high probability breakout opportunities.Unfortunately these breakout opportunities can be a bit vague sometimes. For instance support resistance lines drawn at potential breakout points should be considered event areas rather than fixed lines.
When trading a breakout, you’d do well to exercise great discretion to minimize false signals and fakeouts. However, DO NOT connect the bottom ends of the price action with a straight line. I’m not saying the trend doesn’t exit. It’s just that the trend should not be considered as being contained by a single thin line.
Instead the trend should be viewed as a zone. If price does cut through the upward trend line it doesn’t mean the trend has run out of gas. Sure we have to be mindful of a potential trend reversal. But remember that price does cut through a trend line sometimes without price suffering a reversal. Price suffers dynamic fluctuations, causing minimal breaches through the key levels. This rule is not exclusive to trend lines only. In fact it applies to all levels. Just make sure to identify the real breakouts and filter the fakeouts as much as possible.
Another burning question is:
How Do We Identify The Psychological Levels?
When you see price conforming to the same area repeatedly It can only mean one thing. That a psychological area is in existence . Take the lowest and highest level of price around that level and label the distance between the two lines as a support/resistance area. If you see one the wick of one candlestick go beyond the key level, it’s not part of the psychological area. Let’s look at an illustration of a breakout through a support area using the GBPUSD pair.
Here is a 4 hr chart for the GBPUSD pair. Notice how the bears head down the slope after the bulls run out of steam in the uptrend. Once price reaches a particular level price starts to move sideways, creating a consolidation. This is where both the bears and the bulls are taking a breather to figure out their next move.
Notice the few bottoms that have been created. The blue rectangle represents the area around the lower wicks of the candles which make up the support area. If you really want cash in on breakouts it’s best to lie low like a hunter while a candle close beyond the support/resistance area confirms the breakout. this scenario is nicely illustrated in the bearish breakout as a candle close confirms the breakout. Once confirmation takes place, the bears kick off their downward slope. Let’s take a look at another example
Here is the daily chart for the USD/JPY pair. See how price has formed a descending triangle. Now descending triangles that show price contraction which, you guessed it, leads to a major breakout, reuslting in a new price movement. This means that price could go in either direction as a result of the breakout.
In light od this situation watch like a hawk for possible clues in both support and resistance levels. See how triangles have been framed in the iupper and lower levels of this triangle. This tirangles have been drawn to ascertain the exact areas the support and resistance levels are likely to cover. A look at the lower side of the triangle suggests that there is a candlestick going deep into the support area. If there was just a single line indicating support, the wick might have set a trap thinking there was a bearish breakout. Let’s take a look at another example.
Here is the chart for the USD/JPY pair. See how price has formed a descending triangle. Just so you know, a descending triangle shows price consolidation, which leads to an eventual break out, and then creates a new price direction. The strange thing about this pattern is that it’s hard to tell where the direction is headed. This means the breakout could send price in any direction
In light of this situation, watch both support and resistance levels like a hawk for potential price signals. Any time you sniff a potential breakout, you jump in like a lion chasing his prey. You see how triangles have been created in the upper and lower triangles? This way we know which part of the triangles the support and resistance levels are likely to touch.
Take a close look lower side of the triangle and check the candlestick going deep into the support area. Had there been just a single line symbolizing support, the wick would set a nice trap for you and made you believe a breakout by the bears was imminent.
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Notice in the red circle the location if the breakout to the upside. Aslo see the strong momentum on the breakout as illustrated by the green marabazu candles. Once the bulls break through the upper level of the triangle it retraces back to test an already battered resistance area which has now converted into a support level. This scenario is another important confirmation signal which you need to take note of.
One question that must be burning reader minds might be:
How Can I Tell A Real Break Out From A Fake Breakout?
Well a real breakout only occurs when a pair closes a candle beyond a particular level. This way you get a more reliable breakout signal which you can use to make your entry. Let’s look at an illustration using the USD/JPY pair
Here we have a descending triangle with upper resistance and support areas. See how the rectangles resist the bottoms of the price. The lower rectangle’s location is based on the first and second bottom of the triangle. The triangle contains the upper parts of the price. The only exception is the pin bar rejection candle which is illustrated by its long tail. That’s what you call a fake breakout. However, the candle fails to close with its full body above the resistance area.And when this happens it is classified as a false breakout.
A second false breakout takes place immediately after the first one. The last bottom of the pric goes below the support area with its candle wick. Now when you see such a formation nobody has to tell you that’s a pin bar formation. It is also known as a hammer pattern which then ricochets off the support level. Just like the first scenario we ll disregard this signal since the candle failed to close below the support area.
So the pin bar formation pushes the bulls further up the hill, Next thing we know, a candle in the form of a Marabazou closes above the resistance level. Now that’s what you call a valid breakout signal. This should earn you at least 300 pips.
Look up How To Profit From Trading False Breakouts and Fakeouts
Now that we can tell a real breakout from a fake breakout The most appropriate question should be:
How Do I Confirm Breakouts?
There are fours ways of confirming breakouts. Let’s look at each method one by one
Breakout in Progress
You see how price breaks through the resistance area? When a candles closes above the resistance area, consider that a breakout.
Here we see the bulls continuing with their surge only to run out of steam and let the bears take over. This scenario creates the top. What you should look for is what is called a fractal formation. In this formation you have a higher high(HH) with two bars to the left of the formation and lower highs(LH) with two bars to the right of the formation with lower highs(LH). The reverse applies to a bottom.
Price Retrace To Broken Resistance Area
Here we see price retracing to an already breached support level with the intention of retesting the level again. Price succeeds in breaching the support area, causing an upward ricochet. When this happens, it suggests a strong support level.
Top Breaks
Here we get strong confirmation of the bulls continuing their surge towards the hills. This is a perfect time to put in your entry.
You can also apply this confirmation while trading range consolidations. You have a breakout in a chart pattern and expect the size of price movement to be equal to the size of the chart formation.
And finally the coup de grace
How Do I Take Profit When Trading Breakouts
You can start with swing low and high analysis or candlestick pattern analysis. However one popular technique making the forex rounds these days is Moving Averages. One nice advantage of using moving averages is that you can hold on to your trading position until a candle closes beyond the moving average.
Let’s look at an example using the AUD/USD pair
The pink line represents a 34 day Simple Moving Average(SMA for short). It’s perfect for trading during trending conditions.
You see the blue triangle to our left? It represents a support area that has been struck three times by price. The red circle shows the candle breaking through and closing beyond the support area. How about we use this breakout signal to go short(sell)? The bears start hurtling down right afterwards. You see the numerous times prices attempts to crash through the 34 DAY SMA? Somehow price manages to hold off price effortlessly keeping the trade alive for a very long time.
Price eventually closes a candle above the 34 day SMA. This is your queue to take your profits and run for dear life. You could make a cool 300 pips using this entry and exit strategy.
For More information on Moving Averages look up We are Moving Averages Part I and II
That’s a wrap for How To Profit From Trading Breakouts Step By Step.” With solid price action analysis you should have no problem profiting from trading breakouts. You can also use chart pattern analysis and moving averages to take your profits and head for the exit. You can never go wrong with these two two techniques
Til next time take care.
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