Best way to optimize breakout trading strategy
Break outs are the most common scenarios on the forex market charts that as a forex trader you cannot avoid or control. Breakout trading strategy is one of commonly used strategies by professional traders.
Breakouts can lead to new price movements or trends or sometimes can tend to fake the traders out shaking them off the market.
At the end of this session you will be able to know how to identify breakouts , differentiate break outs from fake outs and ofcourse how you can trade breakouts.
What are Breakouts?
This is when price passes through the defined psychological price levels. These could include support & resistance levels, trend lines, price channels, moving averages, Fibonacci retracement levels, pivot points and chart pattern levels on the market charts.
When you see price hit these levels more often while being rejected and after a while breaks through, that is called a breakout.
Best breakout trading normally occur after a long market consolidation as price has tried several times to break the identified levels of support and resistance but failed on several attempts.
As price ranges between these boundary levels it approaches either the upper end of the range for an up movement or lower end for a down movement and overtakes it with a strong volume and increased volatility.
How do you trade break outs?
Take a look at the AUDUSD, Daily chart below;
From the above chart, you can see how long price battled on resistance level before breaking out.
A break out at a resistance level gives a buy signal. The confirmation for the buy signal is the close of the bullish candlestick above the resistance.
Now let’s look at breakout trading in a down trend
Take a closer look at the GBPJPY 15-minute chart below
Looking at the chart above, it’s clear on how long price battled to break through but on every attempt it found support on the trend line. Ofcourse price can never hold for ever, if finally broke the trend line and this resulted into a strong rally after the breakout. The bearish candle close below trend line is the confirmation for the sell entry.
The longer the market consolidates the more volatile the resulting breakout will be.
When price breaks above or below these identified levels with strong momentum, it moves higher covering many pips within a shortest time possible which has always been a prayer for every trader.
You only enter a trade when price breaks out, and candle closes beyond the trendline in the direction of the new trend and look for exits when volatility goes down or when you approach another level of resistance/support.
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.
What is Volatility?
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 are higher chance of your targets being hit with in a shortest time possible.
When the price is moving steadily or looks like it is not moving at all, then the volatility is low. This is usually identified by congestions and consolidations. Congestions are a result of some traders in the market still holding back on their assets due to lack of confidence or they are conservative and need more confirmation.
The higher the volatility the riskier it is to trade that pair. Very high volatility is characterized by large candles and tails which easily hit stops.
Higher volatility makes forex trading more attractive to the market players especially for day traders and scalpers but not so significant for the long-term investors who buy and hold.
High volatility can still expose you to very high risks therefore before taking any decisions you should have good risk management in place. Like we mentioned before, in such cases price moves so fast that if you had predicted wrongly you make large losses if you had not risk management in plan.
Usually in breakout trading, your entry point should be immediately after the break of the support or resistance level. But if you are a conservative trader, you can wait for a retest back on these levels and enter on the confirmation candlestick pattern.
How long you should hold an open position, is a personal thing for all traders. The decision is all yours. You know what your goals are as a trader, the kind of strategy you use to trade. All this starts from what you are? and What you want? If I am to answer, this...