20. How to trade Breakouts
We know that Forex market is a market which keeps moving when compared to other markets. Price keeps moving and traders need to identify when to enter into trade to make profit. When price moves out of a range or out of levels like Fibonacci, pivot levels, support and resistance a “break out” is said to have occurred. In this article we will learn how to handle breakouts appropriately.
Thus put simply, break out is a point at which price breaks away or moves out of the normal flow. It’s all about market volatility. When price makes large moves, market is said to be more volatile. Forex traders always tend to make money out of this high volatility situation. But, you need to be prepared for breakouts as well. You can turn breakouts to benefit you by making use of the volatility.
There are two types of breakouts:
- Continuation Breakouts
When market moves in one particular direction (uptrend or downtrend) for some time, there is a specific period during which price continues to be in a range between the support and resistance indicating indecision by the traders. This zone is called the consolidation which can occur after a downtrend or an uptrend. Now, traders finally decide that the initial trend was correct, they then push the prices so as to continue the trend which persisted before the consolidation. Thus making the price breakout of the range and hence it is known as continuation breakout.
- Reversal Breakouts
After continuing a trend for long time, the price continues in the consolidation for some time as mentioned before. In this case traders feel that the initial trend was incorrect and they tend to push the price in such a way that starts moving in the opposite direction of the initial trend and this is called the reversal breakout.
In such cases what you can do is wait for the price to hit that breakout level again or to continue in the direction you expect it to move. Don’t be carried away by the false breakout or fake out. Traders often tend to hurry when they see the breakout and end up losing money when they realize that it was a fake out. So, the suggestion here is to wait till you see the price move in the intended direction before you take a position in the market.
Let’s get into the world of trading breakouts now. We will see how to trade breakouts using trend lines, channels and triangles.
Ok so the first possible way to identify a breakout will be to use trend line. When you draw trend lines connecting at least two tops or bottoms you will get to see the direction of the trend on your chart. We know that when the price reaches the trendline it can either continue with the trend or reverse its direction by causing a breakout. In this case we are trying to take advantage of this breakout. This is where you use the appropriate indicators to see if the price would continue in the direction of break out.
Identifying breakouts using channels is similar to that of trend lines. The only difference is that you can identify breakouts in either direction.
First draw a trend line and then another line parallel to this line touching the bottoms which will form a channel as shown in the figure above. As you see, you can easily spot breakouts in either direction. When the price approaches the signal and then breaks out to reverse its direction, make use of the technical indicators to identify possible trading opportunities.
You can use triangles to spot breakouts. We know that a triangle pattern is formed when price converges from being highly volatile towards lower volatility.
There are three types of triangles:
- Ascending Triangle
Ascending triangle is formed between the resistance level and the trend line connecting higher lows. Ascending triangle signals bullish market and chances are that of a breakout towards the uptrend. So as soon as we see that price breakout of the resistance level, the ideal decision should be to go long.
- Descending Triangle
Descending triangle as you can see above are formed between the trend joining lower highs and the support line. Descending triangle signal a bearish trend and hence our aim should be to go short as soon as we see price breaking out of the support level.
- Symmetrical Triangle
As you already know a symmetrical triangle can indicate either an uptrend or downtrend following a breakout. So what should you do? The obvious answer is you should be prepared for both. If the price breaks out and starts moving up, execute your long order and if it moves below, go short. So you should position yourself in such a way you can take advantage of the breakout in either direction.
With breakouts, the criteria is to wait. It is a common practise to hurry up as soon as you see a breakout to touch it, squeeze it and pinch it. We are talking about the one which breakouts on the face. We suggest that a trader should wait and understand the price movement following a breakout. That said, at the end of the day it’s all about volatility. Price changes as we watch. So what should we do? Be ready with your tools and keep watching.