Breakout Trading
by admin on 15/05/09 at 11:31 pm
Breakout trading is used by active investors to take a position within a trend’s early stages. Generally speaking, this strategy can be the starting point for major price moves, expansions in volatility and, when managed properly, can offer limited downside risk. Throughout this article, I’ll walk you through the anatomy of this trade from start to finish and offer a few ideas to better manage this trading style.
What Is a Breakout?
A breakout is a forex price that moves outside a defined support or resistance level with increased volume. A breakout trader enters a long position after the price breaks above resistance or enters a short position after the price breaks below support. Once the currency pair trades beyond the price barrier, volatility tends to increase and prices usually trend in the breakout’s direction. The reason breakouts are such an important trading strategy is because these setups are the starting point for future volatility increases and large price swings. In many circumstances, breakouts are the starting point for major price trends.
Breakouts occur in all types of market environments. Typically, the most explosive price movements are a result of channel breakouts and price pattern breakouts such as triangles, flags or head and shoulders patterns. As volatility contracts during these time frames, it will typically expand after prices move beyond the identified ranges.
Regardless of the time frame, breakout trading is a great strategy. Whether you use intraday, daily or weekly charts, the concepts are universal. You can apply this strategy to day trading, swing trading or any style of trading.
Finding a Good Candidate
When trading breakouts, it is important to consider the underlying price’s support and resistance levels. The more times a price has touched these areas, the more valid these levels are and the more important they become. At the same time, the longer these support and resistance levels have been in play, the better the outcome when the price finally breaks out.
As prices consolidate, various price patterns will occur on the price chart. Formations such as channels, triangles and flags are valuable vehicles when looking for currency pairs to trade. Aside from patterns, consistency and the length of time that a price has adhered to its support or resistance levels are important factors to consider when finding a good candidate to trade.
Short Term Breakout
Short term breakout trading is perhaps the most popular strategy for short term traders.
Short term breakout trading is generally a chart-based strategy that lends itself readily to technical analysis techniques and is an easy tactic for beginning and novice traders to grasp.
This article will touch upon the basic ideas of breakout trading, provide some real-world examples of breakout trades, and give you an easy-to-use simple method that you can implement into your trading strategies right away.
Breakout trading refers to prices “breaking out” of either a technical pattern such as a triangle, a consolidation range or trend channel.
The theory of breakout trading is that price momentum will continue to carry the price far enough beyond the breakout point for the trader to be able to seize a profit. One, three or five minute charts can be used for traders using breakout trading for intraday markets, while daily charts are best for end of day breakout trading.
Breakout trades can be either long or short based on the direction of the break. However, breakout trades will always be with the general direction of prices (i.e., pro-trend) and never against it.
Volume plays a crucial role in choosing breakout trades. A trader should see increasing volume along with the breakout in order to confirm momentum before taking a position. It is important to note that a volume spike at the breakout, followed by a rapid decrease in volume often means that the breakout is weak and vulnerable to failure. Such breakouts should be avoided.
“This sounds like a great way to trade. But just how do I find breakouts?”
When I began my trading journey, it was very difficult to find breakouts in real time, especially in the intraday, which was my focus. Traders have tended to restrict their trading of breakouts to daily charts. Today, it is a far different story. Currency screeners are increasingly built into many trading platforms, and there are resources like the currency screener available in the market that intraday traders can use to spot breakouts that are happening in the intraday time frame.
Exits are discretionary once profits are obtained with this method. Many traders like to use trailing stops to allow profits to build. The one hard and fast rule I strongly suggest is that if prices immediately drop back below the breakout line after you enter the position, then close the position.
You can always re-enter once the price breaks out again. But a failure to continue in the direction of the breakout often leads to losses.
