Breakout trading strategies and indicators
With the breakout trading technique, you take a position at the start of a trend in the hopes of making money from the numerous trades that will come after. Discover the best entry methods for breakout trading as well as how to spot breakouts before they happen.
What is breakout?
A breakout occurs when the price of a securities moves above or below a recognized support or resistance level, frequently triggering a strong bullish or bearish trend. Trading strategies that take advantage of times of high volume and volatility to generate big profits include spotting and entering breakouts early.
A change in a security’s supply and demand is what causes breakouts. More traders start to participate in the movement after the price of an asset crosses a certain threshold, either actively as day traders or passively through different order types.
What is breakout trading?
A trading method called breakout trading takes advantage of the possible price movement during a breakout. In essence, you try to anticipate when a breakthrough will happen and then capitalize on the trend that follows.
The three components of a breakout trader are detecting the breakout, entering the trade, and closing at the right time. The idea is to discover consolidated ranges produced when a price is moving between levels of support and resistance. This is done by looking for breakouts.
TIP: How do breakout trades gain momentum?
The strength of the next trend will increase with the length of time it takes for the price to exit the condensed range. The traders’ activities in relation to the levels of support and resistance are a driving force behind this occurrence.
Many traders may place buy and sell stop orders just beyond these levels when a security trades between support and resistance levels in order to profit from the breakout. Therefore, when a breakout happens, these orders are triggered and give the breakout more momentum.
How to spot breakouts.
You must do two actions in order to identify breakouts. You start by determining the support or resistance levels a market is finding difficult to go through. Second, you watch for a hint that the breakout might be about to happen.
Support and resistance bands, as previously indicated, can take a variety of forms, but they all signify oncoming or potential breakthroughs in the price action. Let’s examine a few prominent illustrations of consolidation patterns.
Rectangle Channel
When the price oscillates between horizontal levels of support and resistance, a pattern known as a rectangle is formed, which causes the entire price action to move in a sideways box. Similar to rectangles, channel patterns signify a bullish or bearish range of trade and are inclined up or down. Angled channels maintain parallel levels of support and resistance, just like horizontal rectangles do.
Triangles and flags
Triangle patterns, which can be ascending or descending or symmetrical, are characterized by converging trendlines joining a succession of highs and lows. Symmetrical triangles have a neutral pattern and two convergent trendlines; the breakout that follows the creation of a symmetrical triangle usually moves in the direction of the current trend.
In an ascending triangle, the lower trendline is narrow and makes higher lows while the top trendline is flat. This pattern shows that buyers are more active than sellers, and an upward breakout is most likely.
The opposite of an ascending pattern is a descending triangle. The higher trendline slopes downward from the price making lower highs, while the bottom trendline remains flat. In declining triangles, the price frequently finally penetrates the bottom trendline.
In comparison to triangles, flag patterns, also known as pennants, exhibit less pronounced trend line convergences. When price action spikes or plunges sharply in the direction of the current trend, a pattern is formed that has a “flagpole” at the beginning. Then, after a period of consolidation, prices break out once more in the same direction as the original flagpole.
Head and shoulder
Three peaks serve as the baseline for head and shoulders patterns, with the center peak being the tallest and the first and third peaks being relatively similar in height. This pattern frequently comes before a breakout-based bullish-to-bearish reversal.
Cup and handle
When price action shapes a u-shaped cup and subsequently a downward-drifting handle, the cup and handle pattern is formed. After a brief downturn, the price will break over the resistance level at the cup’s rim, signaling a bullish continuation.
Breakout Chart Patterns
The time has come to search for a breakthrough signal once levels of support and resistance have been established. The majority of traders do this with the aid of indicators, which may also be used to assess the strength of approaching breakouts.
In addition to indicators, many traders may monitor a market’s volume while looking for a breakout. An increase in volume might be a reliable sign of a powerful breakout that establishes a long-lasting trend.
MACD
Several moving averages are used by the Moving Average Convergence Divergence (MACD) indicator to assess recent price changes, allowing you to determine momentum when price movement approaches or crosses lines of support and resistance. On the other hand, traders can also use MACD to identify trends that are losing momentum, which will help them decide whether to leave a trade after joining the breakout.
Bollinger Bands
Bollinger Bands are a tool for identifying whether price fluctuation is shifting into a trend. They use lines of standard deviation and a 20-day simple moving average (SMA). A reversal breakout may happen when the price’s SMA crosses above or below lines of standard deviation. Combining Bollinger Bands and the MACD can let you see the strength of the Bollinger Bands’ potential reversals indicator, which will help you reinforce this signal.
RSI
When a security is overbought or oversold, the Relative Strength Index (RSI) indicates that the price may be about to pivot in the other direction. A breakout is more likely to happen the more pronounced the price reversal.
You can also utilize a volume RSI chart, in which the up-volume and down-volume components of the formula are used instead of price movements.
How to trade breakouts
Plan your entry point once you’ve identified a potential breakthrough.
A breakout can be entered three times: just before it happens, during it, and right after it. Every one has a different level of risk and reward.
| Entrance | Method | Benefits | Drawbacks |
| Before the breakout | While the price is still trading in the bounded range, enter a position in the direction you believe the breakout will occur. | Avoid high slippage and volatility, likely to get a better price. | Your trade is more susceptible to false breakouts. |
| On the breakout | Set an order to be filled right beyond the support or resistance level you suspect a breakout to occur on. | You’ll quickly know if the breakout is real or false and whether to close out early. | Your entry may experience higher slippage and volatility than entering before the breakout. |
| After the breakout | Wait for a pullback after the breakout, then trade the new trend using the previous line of support or resistance as the new resistance or support. | Safeguards against false breakouts and provides the ability to ride the new trend once short-term traders have taken their profit. | While you are entering at the safest point, your profits won’t be as high as traders who enter earlier. |
How to close your breakout trade
Planning your exit is just as important for making money from breakout trading as planning your entry. You should try to determine a suitable profit aim and set stop and limits correctly before you initiate your trade.
Establishing a profit objective
Your profit goal might be determined in a number of ways. One approach, for instance, is to analyze recent price movement and choose an objective based on the range of price movement displayed prior to the breakout. A reasonable goal may be six points in the breakout direction if the support and resistance levels were six points apart. You can average the price swings and use that figure as your aim for non-parallel ranges such as descending triangles.
Exiting with a loss
The relative quickness at which you can recognize when a breakout is false is another benefit of the breakout trading technique. In a typical breakout, previous levels of support should act as new levels of resistance, and previous levels of resistance should act as levels of support. A false breakout is indicated if the price crosses back over one of the initial levels. Once you’ve placed the trade, you can use stop-loss orders to limit your losses or protect yourself by exiting the transaction as soon as the failed breakout is confirmed.
How to trade a breakout in forex
Forex breakout trading is quite similar to trading in other markets, with the exception that you can’t gauge volume thus you’ll have to rely solely on volatility.
Waiting for the start of a new trading session, such as the London or New York area, will make it simple to time volatility while trading forex (the two busiest in forex trading). The volatility of connected majors will increase at the beginning of the sessions.
The European Opening Range breakout tactic is a good illustration. At the start of the London or European trading session, you should concentrate on EUR/USD or any other important European currency. View instances of the European Opening Range tactic and learn more about it.
One of the most well-liked forex trading techniques is the breakout. In just a few simple steps, you can start trading breakouts on FOREX.com:
- Open a PepperStone account or log in if you’re already a customer
- Search for the currency pairs you want to trade, preferably ones that are experiencing strong support and resistance levels
- Identify levels of support and resistance, set your stops and limits
- Wait for a breakout, which you can confirm with the indicators mentioned below, and enter your trade at the beginning of the trend
How to identify false breakouts
The price of a securities may briefly cross over a support or resistance level before falling or rising back into the trading range it was previously in. Traders frequently misjudge the locations of support and resistance, which results in what is known as a false or failed breakout.
High volume can distinguish between a genuine breakthrough and a fake one, as we’ve discussed. Volume indicators can be used to determine the strength of a breakout and the age of support and resistance levels. When the price reaches areas of support or resistance, volume should increase; otherwise, any breakout above these levels may be a fake-out.
Stop-loss orders are essential to breakout trading since you can only tell if a breakout is false once it returns to its previous range. Setting a stop-loss order near the level of support or resistance involved in the breakout can shield you from incurring losses in the event of a false breakout, as was indicated in the exits section.
