Breakout trading can be a highly effective technique when trader’s make the correct decision on a large, profitable, market move following a period of consolidation. These areas of consolidation are very common across all time frames and are formed with continuous sideways movements, between areas of support and resistance. Very often, this evidence of an undecided market, where neither bulls or bears control the short-term trend, results in price ‘breaking out’ higher or lower with substantial momentum and provides an excellent trading opportunity.
Trading breakouts with a conservative trading strategy
Breakouts are obvious when price bursts through an area of continuous support or resistance but knowing if price will continue in this direction if often not immediately clear. The reason for this is the existence of ‘false breakouts’ whereby price appears to move out of the area of consolidation before reversing and returning to this area or even moving to breakout in the opposite direction. Taking a trade as soon as the breakout occurs can leave traders trapped if price reverses and therefore many will prefer to wait for confirmation of the breakout before entering. This is known as a reasonably conservative breakout strategy and, although some opportunities may be missed by employing this, it is highly effective in lowering the risk of losses.
The strategy involves waiting for the initial breakout to move beyond the area of support and resistance before returning to this level as many breakouts invariably do. This is known as a retest of the breakout level in order to prove that this has now become a new level of support or resistance and price can continue in the direction of the breakout. With false breakouts, this level will not be proven to support the breakout and it is likely that price will crash back through this. On the return to this level, traders may look for key signals that support the direction of the breakout. This can be in the form of reversal candlestick patterns, or technical indicators which can both provide an idea on whether the market considers the initial breakout to be genuine and confirmed.
Aggressive breakout trading
For short-term news traders, breakouts often occur in the seconds and minutes after significant news is released to the market. If the news is relatively unknown or likely to have a strong impact on forex pairs, it is typical that the markets may move sideways in the lead-up to the release. Cautious trading will be evident with price moving between a lower and higher support and resistance level as the market waits to find out which way to move. This provides breakout traders with an excellent opportunity to catch large movements immediately on the release, although this strategy favours those with nimble fingers to react with the market.
An additional way to aggressively trade a large news release is to patiently wait for the market to react before entering a contrarian trade when these become over-stretched. The assumption here is that in the minutes following a news release, the high volumes of buying or selling cause the market to overreact which will often result in a breakout to spike higher or lower followed by a period of consolidation or a slight retrace of this move. Assuming that currency markets will return to normal trading shortly after the news is released provides an opportunity to trade against the breakout when price begins to falter. Although this is a strategy best employed by experienced news traders, it can be witnessed frequently with both candlesticks and indicators assisting traders to pinpoint when the market may be overextended.
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