Summary on break outs and fake outs

A price breakout occurs on the defined psychological price levels in the market such as support and resistance levels, trendlines, price channels, moving averages, Fibonacci retracement levels, pivot points and chart pattern levels on the market charts.

Breakouts normally occur after a long price consolidation or several test of price on the levels of support and resistance or at end of price trend.

Break outs can be traded in two ways;

Entry at the close of the confirmation candle that makes a breakout and exit when the volatility dies out (aggressive trader).

Wait for price retest on the break out level and enter trade on the second confirmation (conservative trader).

The longer the price consolidates the stronger the resulting breakout is likely to be.

Volatility is the rate at which the market moves.

When there is a very strong price movement within a short time after a break out, we say the volatility is very high and there is higher chance of your targets being hit with in a shortest time possible.

When the price is moving steadily slow or looks like it is not moving at all, then the volatility is low. Your targets should not be set very far from the entry level because with low volatility price is not likely to move very far.

A breakout is sometimes followed by a small price retrace resulting from the abrupt shift in the supply and demand as it seeks to re-balance. A continuation after that small retest is a strong confirmation that price will cover several movements before retracing back.

High volatility can still expose you to very high risks therefore before taking any decisions you should have good risk management in place.

Some volatility indicators that can be used to gauge the state of market and  to know the strength of the trend, possible breakouts and potential market reversals include.

The average true range (ATR)

ATR measures volatility by showing the average trading range of the market for a given period of time. It grows along with volatility and falls with it.

When ATR is rising, it shows that volatility is also rising whereas when it is falling it is an indication that volatility is dropping down.

Bollinger bands

The bands move along following price and normally contract when volatility is low and widen when volatility is high.

On contraction, low volatility.

Expansion, high volatility

Types of breakouts

Continuation break outs

These occur when currency prices have been in a consolidation and later continue in the current direction.

Reversal breakouts

They tend appear after the exhaustion of the trend or consolidation. This is when the currency has moved in one direction for a long time and has been overbought and sold.

How to identify breakouts?

Break outs can be identified by looking at:

  • Support and resistance levels
  • Channels
  • Trendlines
  • Triangles
  • Chart patterns and using indicators.

Some of the indicators used to measure the strength of a breakout include:

Moving average convergence divergence MACD

Relative strength index RSI

False breakout

This happens when price breaks out the defined levels of support and resistance for a short time and does not continue but moves back to the opposite direction.

Fade the breakouts

To fade the breakouts simply means to trade the fakeouts or trading in the opposite direction of a breakout.

If you consider a breakout to be fake and has no or very few chances of keeping in the same direction as a break you can trade it to.

Trading fakeouts is a bit tricky because a breakout may fail on its first attempt but ends up succeeding in the long run. With this kind of character they have to be traded as short term strategies.

Whether trading a breakout or a fakeout, always wait for a clear confirmation before executing a position. Use stop loss levels which will help you limit the loss in case a trade doesn’t go as expected.

 

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