Hello and welcome to another edition of the bulls vs the bears. Today we are going to learn how to profit from trading false breakouts and fakeouts. You see trading breakouts is a very profitable strategy. Only that sometimes breakouts do not quite materialize,a and instead do a nasty about turn on you, causing your trading position and your trading account to go out in smoke,
The good news is you can anticipate what’s happening and react like like a marksman to this type of situation. You can be profitable with false breakouts and fakeouts if you know what you are doing. So we’ll take a close look at what false breakouts and fakeouts really are and how to trade them.
But before we go on I suggest you read up on How to Trade and Crush the False Break and How to Trade the Fakey Pattern . Failure to d that and you will be scratching your hair this entire lesson. First off:
What are False Breakouts?
False breakouts are sightings where price breaks through a key level, and then suddenly does a sharp change in direction. What’s so crazy about this scenario is that traders, desperate to make a quick buck are sucked into the direction of the initial breakout. Then when price goes into sudden reverse, it triggers a series of stop orders by these gullible traders. Of course it completely turns their day upside down.
The entry of these gullible traders puts further pressure on price, It is this reaction that results into the false break. Now let’s see an illustration of the false break and reversal in action.
Ladies and gentlemen, here is an illustration of a false break using via the GBP/USD pair. The pattern marked in blue is the inverted Head and Shoulders pattern. The neck line, marked in magenta is considered the signal line. Notice the upside breakout(marked in red) through the neckline. This breakout confirms the formation of the Inverted Head and Shoulders pattern and suggests the bulls are about to take off. Unfortunately price quickly repulses the bulls advance.
This causes price to sharply reverse and set the bears on a wild slalom the size of the Head and Shoulders pattern.
How Powerful is the Fakeout Pattern?
Let me tell you that the fakeout pattern is vert powerful. When you have been faked out by a breakout, you will realize that the profit opportunities are substantial. All you need is the sharp eyes of a marksman for you to take advantage of the trading opportunities.
If you find a false break on the upside, just put in a sell order on the assumption that a pullback is about to happen. If a false break is on the downside, then expect the bulls to to do a pullback. Of course this creates a long trading opportunity. And you will be crazy if you don’t take advantage of this bullish opportunity.
Sounds simple right? However there is one exception. Like mentioned earlier, you must be able to tell the difference between a fakeout and a real breakout, Failure to do that and you will be gnashing your teeth and pulling your hair all day. The best way to do this by studying previous patterns on your charts. Once you muster this, it should be like riding a bike for you.
How Do I Identify False Breakout Patterns?
Now this is the deadliest aspect of trading breakouts. Failure to identify a false breakout properly and you will lose a lot of cash. There may be times when you completely misread the price action for a false break and price returns to the initial breakout point. Next thing you know price confirms the initial breakout and follows the direction of the initial breakout. It’s happened to me quite a lot. I know what I’m talking about.
First of, keep an eye on the volume of trading. Real breakouts are usually characterized by a strong trading volume in the direction of the breakout. IF there is no trading present during the breakout, don’t bother putting in an order. If you do, you will burn all your fingers. Let’s look at an illustration using the GBP/JPY pair
Here is an illustration of an actual breakout in its pomp. The volume indicator at the bottom of the chart shows high trading volumes(as indicated by the green arrow) at the time of the breakout. See how price follows the direction of the break after the breakout. With such a high volume the opportunity to trade the trendline break to the downside is quite significant.
Now let’s look at an illustration of a fakeout pattern in action using the GBP/USD pair.
Ladies and gentlemen, here is an illustration of a fakeout pattern in action(As indicated by the red circle). It shows resistance at $14700. After numerous retests of that level, price eventually closes above the $1.4700. Nobody needs to tell you you need to put in a buy order here.
Unfortunately the Volume Indicator does not give us much to work with here. Sure we price do a sharp reversal. However that leads to a fakeout setup-something none of us want. When the Volume Indicator is not helping just switch time frames to see if there is any evidence of a breakout or fakeout. It’s very possible there is a pullback which is not evident on the initial time frame.
When to Enter Fakeout Trades?
Timing is everything when entering fakeout trades. When you spot a low volume of trade , don’t enter until price returns to test the initial level. But if price returns with a higher momentum, then it’s like to be a false breakout.If the bulls break through on a low volume, put in a sell order on a bearish pullback.
The key level takes many forms. It could be a horizontal support or resistance level, a diagonal trend line, or a price channel, pivot point, chart pattern, candle pattern, e.t.c.
Placing Stop Loss on Breakouts
Like we said earlier, a real breakout pattern can easily pose as a fakeout pattern test a level, and follow in the direction of the breakout. In light of this, you’d do well to protect your trade with a stop loss
. I can hear someone asking”Where do I place the stop loss?” Well, you will want to place your stop loss on the opposite side of the breakout. Let’s take a look at the illustration using the same GBP/USD pai we used earlier.
As you can see the stop loss is placed nicely on the opposite side of the breakout. The price is likely to do a sharp reversal anyways,. So you might as well make the stop loss tight. Once price breaches the key level, it’s confirmation that the breakout is legitimate.
Entry Point When Trading Fakeouts
Timing is everything when trading fakeouts. It could be the difference between the difference between prosperity and poverty. You only enter the market when the trading volume leading to the breakout is very low and the price has returned to test the key level in question. But if price’s retest of the key level occurs with a high momentum, compared to the break, then it’s a fakeout.
If the bulls break the key level on a low volume of trading, you just pull in a sell order on a bearish pullback. The pull back could come in many variations; it could be a horizontal support/resistance level, a trend line, a price channel, a Fibonacci level,a pivot point, a chart pattern, a candle pattern, e.t.c.
How to Place a Stop Loss on Fake Breakouts
You need to get your risk management spot on when trading fakeouts. Why? Because prices tend to be very unpredictable in these area. Like I said a a break can pose as a fakeout, test the key level, and then follow the path of the original breakout. With that in mind, always your trading position with a stop loss. I can hear someone asking”Where do I place the stop loss?” The best spot to place the stop loss is on the opposite side of the initial breakout. Let’s take a look at this scenario using the GBP/USD pair. with the previous chart.
This is the same chart we used previously. Except that a nice spot has been prepared for the stop loss. Since the price is likely to do a sharp 360 after the fakeout, make sure the stop loss is very tight so you avoid a major crash on your trading position. Because once price breaks this level, that will be confirmation that the breakout is valid.
That’s a wrap for Some Costly mistakes You Should Avoid Like The Plague As A Forex Trader”.” Just make sure you you cut down to the barest minimum the above mistakes that you make. There is no such thing as a perfect trader. You are learning all the time. The trick is no to keep making trhe same mistakes over and over again. Even more important, you ate constantly learning as a forex trader. Just look for ways to be a efficient as a forex trader.
No Need For Targets in Fakeout Trading
You don’t need to set specific targets in fakeout trading. When you spot a fakeout you just measure the formation size and apply it from the opposite side of the formation, starting from the extreme end. When the trading volume on the fakeout drops, you should see the volume pickup during the pullback.
So long as the trading volume is high just hold your trade for as long as possible. The moment then volume drops just close your trade take your profits and head for the exit. Now let’s take a look at a few examples of what we’ve been talking about thus far.
Here we have the H1 chart of the GBP/USD pair. Below the chart we have the Volume Indicator. We have a bullish trade posing as a false breakout and a reversal. Notice the strong support being whacked several times at 1,2790. Suddenly a bearish candle closes below the support level. When this happens you’re like “Hmmm I could put out a sell order here.”
Not so fast cowboy!Take a close look at the trading volume leading to the breakout. It does scream “FAKEOUT!”Why? because there is a steady drop in the trading volume. This makes the breakout suspect. And when you have a dubious breakout, you guessed it, you have a false breakout.
Now notice the huge rejection by the bulls in the engulfing pattern. This is the perfect opportunity to put in a buy order. Just make sure the price increase is very sharp for you to make your entry. Of course you have to protect your trade with the stop loss we discussed earlier. Just place your stop loss in the engulfing pattern.
Luckily for us the price increase creates the pullback we’ve been anticipating all this while. See how the Volume Indicator is reading huge trading action? This suggests price is moving to the upside. Afterwards trading volume drops, resulting in price losing steam. And when that happens, close the trade, take your profits and run like your life is at stake.
Now let’s take a look at another example.
We have the H1 charT of the USD/JPY PAIR. Only this time we are using the popular Rising Wedge pattern.(marked in pink.) Now the Rising Wedge is a result of a correction appearing while the bears were in charge. As the wedge takes shape we see a drop in trading volume. This is because the Rising wdge is more consolidated. The players are taking a break to consider their next move.
However, we see price slicing the wedge through the upper level. Consider that as a possible false break. We also see an increase in trade volume during the bulls break. Treat that with a grain of salt as this suggests a false breakout. Why? Because it has bearish potential written all over it. A bearish doji shows up after the break. Of course a doji has indecision or reversal written all over it,
With this information at your disposal, consider putting in an entry at the close of the doji candle. Put in your Stop Order above the High created by the potential false breakout, In so doing you protect your trade in case the bulls take over.
See how price spikes sharply when the bears take over after the pullback? Also the Volume indicator records high trading traffic from the downside rest as the bears run out of gas.
After a long while, the trading volume begins to drop. That should tell you that price is running out of gas. Now will be a good time to take your profits and run(as indicated by the arrow).
That’s a wrap for “How to Profit From Trading False Breakouts and Fakeouts .” Yes it’s possible to profit from breakouts and breakouts. But you need to anticipate these unfolding events well if you want to your cash register to ring. Sometimes what seems to be a breakout might turn out to be false, causing you to lie flat on your face.
Just don’t be in a hurry to jump into the market yet. Just wait for confirmation, with your volume indicator as your guide. If the trading volume leading to the breakout is high, jump in. If the volume is low, hold your horses.
Til next time take care.
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