Today we’re going to learn how to cash in on trading breakouts. It’s my fancy way of saying we are going to learn how to trade breakouts. No, we’re not talking about the major zit breakout you experienced when you were a teenager..No this breakout happens around psychological levels such as support levels, pivot points, e.t.c
.Breakouts are great opportunities to make profits. They are a result of the bulls pushing the prices up and heading for the hills. Breakouts are fun to trade because you get to pick up a ton of cash along the trail if you recognize the opportunities quickly enough.
So we are going to do what we always do. Find how breakouts occur, the types of breakouts, and how to trade them.
How Do Breakouts Occur?
Well,breakouts ‘break out’ (For want of a better word) of a consolidation or trading range. Once the heavy players have taken a breather , they continue with their journey.
Breakouts also occur when a specific level such as support and resistance levels, pivot points,e.t.c.The main objective behind breakout trades is to make your entry just when the price breaks out. You then enjoy the ride until volatility fades away.
Speaking of volatility
Think Volatility Not Volume
Why should you think volatility and not volume? Because it’s difficult having a graphic illustration of the volume of trades. In view of this deficiency, it becomes even more important to rely on solid risk management in order to take advantage of a price breakout.
If price movement increases within a short space of time, then volatility is considered on the high side. However, if there is little price movement within that same short space of time then volatility is considered on the low side.
Sure, it’s tempting to move into the market when it’s moving as fast as a speed train. However,you risk spiking your anxiety levels,resulting in poor decision making resulting in heavy losses from impulsive trading. In as much as high volatility attracts forex traders like a magnet. It is this same volatility that kills of al lot of forex traders of the forex market.
So what’s the moral of the lesson? Use volatility to your advantage.Instead of following the herd and lumping head on into the market, it makes perfect sense to scope for currency pairs with low volatility. This way you will be in a position to take advantage of breakouts and sky high volatility.
And while we’re still on the subject of Volatility
How Do We Measure Volatility?
You can use the following indicators to measure volatility. They come highly recommended . First:
Moving averages are probably the most popular indicator used by forex traders. It may look simple, but boy does it provide crucial data for as far as making trading decisions are concerned. In simple language, moving averages measure the average movement of the forex market over a period of time, wherever you want that time frame to be located.
As you can see, the blue line represents the numerous averages set to measure specific periods over a period of time. If you want to refresh your knowledge of moving averages, read up on We Are Moving Averages Part One and We Are Moving Averages Part Two
Next up is
Average True Range
Don’t panic! The average true range is not a lie detector machine. It merely averages the average trading range of the market over a period of time. You can choose whichever time frame that you want to analyze.
Let’s say you set ATR to 20 days on a daily chart . The ATR will show you the average trading range for the past 20 days for the past 20 days. Let’s see how the ATR looks like.
When ATR falls,it suggests volatility is dropping as suggested by the yellow shaded area But according to the coconut color, when ATR rises, it’s an indication that ATR is on the rise.
Now onward to:
Types of Breakouts to Trade
There are two types of breakouts you need to keep in mind i fyou’re contemplating trading breakouts. Even more important,knowing the type of breakout staring you in the face will help you make sense of the happenings on the market. Even more important, the constant change in supply and demand of the currency pair that you’re trading in triggers huge moves resulting in huge opportunities to rack up some valuable pips.
Continuation breakouts are situations where major players break out of trading ranges after periods of consolidation. Here traders take a breather after a long protracted battle trying to jockey for trading position. Once they’ve caught their breath, the traders break out of the range – be it uptrend. Let’s see what the consolidation looks like
As you can see in this example, sellers have taken a breather after duking it out with the bulls. The tight range within the two channels reflect the period of consolidation. During this time,they’re figuring out what to do next. The next step most likely is the continuation breakout. Let’s see what this show looks like.
As you can see, the sellers have made up their minds to launch one final push through the resistance barrier.They’ve agreed to sustain the original trend and that they believe the sensible thing to do would be to break the barrier down and head for the hills..
Just like their brethren in continuation breakouts players also take a breather after locking horns with each other. However there is a difference. The difference here is that the prevailing trend loses momentum after the players’ ability to sustain the trend begins to evaporate. consequently price is pushed in the opposite direction,resulting in a reversal breakout.
And now to the most exciting part:
How to Trade Breakouts
How do you trade breakouts? Well you can trade breakouts with three tools – trend lines, channels,and triangles. You don’t need to look in the mirror for these boys.If you’re able to master recognizing breakouts,you should be able to recognize potential trades at the blink of an eye.First of:
One way of spotting an imminent breakout is drawing trend lines. Now how do you draw a trend line? Just pull up a chart and draw a line that aligns with the current trend. When drawing the trend line make sure it connects at least two tops or bottoms – nothing more, nothing less.
Even better, the more tops or bottoms you are able to connect, the stronger your trend line. I guess the more the merrier. Let’s see how the trend line looks like.
The three yellow circles indicate the tops and the bottoms on the downtrend. Since they satisfy the requirements for drawing a trend line, you just draw a trend line right through them. The one thing you do not want to do is force non-existent tops nor bottoms on a trend line. That will cost you a lot of money.
How Do we Trade?
When the price approaches the trend line, make sure two things happen:
- Either the price ricochets off the trend line and continues on its merry way.
- Or the price rams through the trend line and forces a reversal.
If you don’t want to strain your eyes just looking at the price, you can always call on moving averages or the average trade range to sort things out for you.
Speaking of trading, we can look at it two ways, if the bulls break upwards, it’s time to go long(buy.) But if the bears force a reversal and go on a slalom, it’s time to go short(sell). Let’s take a look at the bearish reversal
As you can see, the yellow circle indicates the beginning of the bearish reversal at the resistance level. after the bullish fade away. And when you have a bearish reversal, it’s time to go short. If you want to know more about trend lines read up on Drawing and Trading Trend Lines
Next up is
Channels are just another way of spotting breakout trading opportunities. Trend channels are very similar to trend lines. Except that trend channels have one extra trend line. This extra trend line helps spot extra trading opportunities, which should make life very rosy for a lot of traders out there. Even better, you can spot breakouts on either side of the trend. Let’s see what the channel scenario looks like.
This is what the rising channel. You have a an extra trend line on the other side, which should create a bonanza of breakout opportunities. The yellow circles symbolize those opportunities. You will have to be blind not to spot these opportunities.
How Do We Trade Channels?
Well, you use the same approach for the trend lines. Just wait for the price to hit one of the channels. Or you can employ the services any of the two indicators we mentioned earlier. And just like the trend lines, if the bulls break out first, go Long. But if the bears force a reversal and break out go short. Let’s take a look at a bearish situation.
The bears have forced a reversal at the resistance level. This of course has triggered a bearish slalom down the slopes. Such a scenario should signal to you saying “TIME TO GO SHORT!” If you want to add to your channel knowledge, call on We’re Going To Talk Channels
Now that we’re done with trend lines and channels, the next set of breakout patterns we’re going to look at are:
Triangles are just as potent as far as spotting breakout opportunities are concerned. Triangles take shape when price starts off wobbly and consolidates into a tight range. And if you’ve seen the phrase”consolidates into a tight range” You’d know that the players are taking a breather to regroup. Your job as a trader is to stay on the alert like a greyhound for possible breakout opportunities, when the big players decide to resume their journey.
There are three triangles we’ll be looking at. The first set of triangles are:
Now ascending triangles come about when a support level spring up causing price to create lower highs. For the bears this is bad news as the bulls are slowly gaining upon them. Let’s see how this scenario plays out.
The resistance barrier forms nicely with the price creating higher lows. Notice how the higher lows channel intersects with the resistance barrier to form the ascending triangle. As you can see the bulls are gaining on the bulls in the manner in which they keep hammering on the resistance. It’s only a matter of time they break out and head for the hills.
Speaking of breakouts in, here is how they pan out. Whenever price reaches the support level , the beas these funny ideas about selling at that level. This of, course forces the price to drop. However, on the other side of the divide, you have these bulls who are like “Hold it, we ought to push the price higher.” So as the price drops,the bulls force the press higher than the previous low. The ultimate result is an almighty tug of war between the bears and the bulls.
Which brings us to:
How Do We Trade The Ascending Triangle?
Since ascending triangles are bullish signals, look out for a breakout upstairs. Once you see the resistance level being breached, that’s your queue to go long(or buy). Let’s take a look at how this setup pans out.
The yellow circle indicates the bulls breaking through the resistance barrier. Once the bulls break through and head for the hills, it’s time to place your order to go long.
Next up is
Descending triangles are pretty much self explanatory. Arent they?. Unlike the ascending triangles which are dominated by the bulls, the bears run the show. Their attitude is”We’re going to set the price ourselves.” As a result, they steal the thunder from the bulls, which puts a lot of pressure on the bulls. Consequently,this creates lower highs along the higher side of the triange(or resistance level)which are met head on by a stiff support level. Let’s see how this scenario plays out.
Notice how the bears have created lower highs, triggered by the pressure they put on the bulls. However, the bears are met by a strong support barrier.
How Do We Trade Descending Triangles?
Well we know descending triangles are bearish signals. Right? So should the bears break through the support level and go on their slalom run, that’s your queue to place your order to go short(buy.) Here is how the trade plays out
The symmetrical triangle is an interesting beast. Why? Because there is not even a whiff of a support or resistance level in this set up. However, both bears and bulls create highs and lows simultaneously, resulting in a weird-looking apex in the process. Let’s take a look at how the symmetrical triangle looks like.
As you can see, the bulls and the bears are trying to outdo each other with higher lows and lower highs respectively. It’s almost as if they’ve been caught in a trap and are struggling to burst out of it.The question is how do they break out of this trap?
Which brings us to:
How Do We Trade Symmetrical Triangles?
As you’re well aware symmetrical triangles are not equipped with support and resistance levels. So you have a simple option! Just get ready for a jail break on either side of the divide. Let’s see how the jail break preparation looks likE
As illustrated clearly,the bulls and the bears are getting ready to break out of their respective jail cells. The green represents bulls about to head for the hills, while the red arrow points to the bears about to do their regular slalom down the slopes. Whoever breaks out first you have to capitalize on their trail.
Now let’s see where to place our entries when the bears and the bulls eventually break out of jail
We see that bulls are the first to break out of jail. So when the jail breakout starts you place your long entry just above the triangle To protect your position from a possible 360 U-turn by the market, gently place a short entry below the triangle. You can’t wrong with that.
Now let’s see where to place our orders in the bearish slalom(downward breakout).
As you can see the bears don’t want to be left out of the fun either. They’ve also initiated their own jailbreak, as indicated by the green shade.So when the jail break is on, gently place your short(sell) order above the triangle. To protect your position,in case the market starts sneezing, place your stop loss below the triangle.
That’s a wrap for “Break Out Trading Breakouts. ” Trading breakouts can be tons of fun. You get to pick up lots of pips along the trail, if you can recognize the opportunities quickly enough.
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Til next time take care.
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