Many novices are concerned about phoney breakouts. When you initially start trading, one of the first techniques you find or feel forced to trade is a breakout strategy.
The goal of a breakout strategy is to capture a major move that follows an easy-to-spot pattern, whether it’s a breakout from a range, another chart pattern like a triangle, or just a small price consolidation.
However, occasionally you don’t get what you want, and a phoney breakout appears.
So, what exactly is a phoney breakout? How can you prevent it, and can you trade it?
These questions will be addressed in this handbook. As a result, make sure to stay with it all the way to the conclusion.
What exactly are phoney breakouts?
A fake breakout is exactly that: a breakout that did not continue over a specific level, resulting in a false breakout.
A stock, currency, or futures contract looks to shift in one direction following a breakout. Traders enter, and the market quickly reverses course, shutting them out or putting them in a losing position.
Fake breakout patterns are one of the most important market action trading patterns to master since a fake break is either a strong indicator that price is likely to reverse direction or a trend is about to restart.
Because it appears that the price may break out but then quickly reverse, a false break of a level can be looked at as a market’s “deceit.”
When a stock trades above a price barrier, volatility rises, and prices tend to move in the breakout direction. Breakouts are an important trading strategy because they serve as the catalyst for potential volatility spikes, considerable price swings, and, in many cases, major price movements.
Breakouts can happen in any market environment. Channel breakouts and price trend breakouts, such as triangles, flags, or head and shoulders patterns, are often the source of the most extreme market movements.
Volatility typically expands if prices depart from the identified ranges and contracts throughout these time intervals.
It’s worth remembering that false breakouts occur on a frequent basis across all time frames. It is not profitable to trade every false breakout. False breakouts should be traded in the direction of the trend.
How can you trade phoney breakouts while avoiding them?
So, how do you stay away from phoney breakouts?
If you’re frequently frustrated by false breakouts, the market is trying to convince you something. Why not trade the phoney breakout instead of missing the real one? Could you earn money trading alongside other traders if you’re continuously going bankrupt due to false breakouts? You can, and it’s a terrific technique, but patience, concentration, and reflexes are required.
Here are three key points to remember in order to trade these breakouts and escape them:
Recognize volume and pattern
No trader can tell if the breakout will be a false break or if it will succeed. The market decides and commands, as it always does, and we traders must listen and obey — not the other way around.
Many traders make the error of observing and forecasting the markets before blaming the market for their strategy’s failure to execute. This is not how trading works.
You must find trade volume, which acts as a price guide. Also, keep in mind that breakout trade setups occur following the emergence of chart trends. It’s vital to study and recognise all chart patterns, or at least the most popular ones.
Take a look at the AARTI DRUGS chart below, for example. Following the trade volume, there is a huge breakout.
2. Identifying major areas of support and opposition
Keep the underlying asset’s support and resistance levels in mind when trading breakouts. The more times certain levels have been touched by an asset price, the more accurate and significant they become. At the same time, the longer these levels of support and resistance remain in place, the better the stock price will do when it finally breaks through.
As rates consolidate, many market movements will emerge on the price chart. Formations like channels, triangles, and flags can be handy when looking for stocks to trade.
Aside from patterns, consistency and the length of time a stock price has remained within its support or resistance zones are important factors to consider when choosing a trading strategy.
3. Keeping an eye out for a reversal
You can trade breakouts by honing in on a single time period and waiting for a downturn. If a pattern appears on a four-hour chart, for example, you can zoom in to a one-hour chart and look for a smaller pattern in that time period.
And the formation of a trend after a strong breakout implies that the breakout was not a fake breakout. It shows that prices are forming a new correction as a result of momentum. This is a cue to keep on.
In the lower time frame, the correction must be brief. It’s fine to use anything from 13 to 24 candles. A range of 24 to 36 may be reasonable, depending on the overall market structure.
How do you get into trades?
The preceding examples provide an overview of trading breakouts. But where is the best place to start?
Once prices are predicted to close above a resistance level, you will enter a bullish position. If prices are predicted to close below a support level, you will take a bearish position.
To determine the difference between a breakout and a fakeout, wait for confirmation.
If you act too fast or without confirmation, there is no guarantee that prices will continue to grow.
Many traders look for evidence in the form of above-average volume, or they wait until the end of a trading session to see whether shares can hold the levels they’ve broken out of.
How do you get out of a trade?
To set a relative price objective, the ideal exit strategy is to average recent market swings. If an asset has produced an average price movement of four points during the last few swings, this is a reasonable profit target.
It’s critical to recognise when a trade has failed. Breakout trading offers this viewpoint in a simple and plain method. Previous resistance levels should function as new support after a breakout, and old support levels should serve as new resistance. This is an important feature since it provides a reliable means to determine when a transaction has failed and a straightforward way to place a stop-loss order.
Use the prior support or resistance level as a guide after you’ve taken a position.
When trading false breakouts, there are a few things to keep in mind.
1.) In trending markets, range-bound markets, and markets moving against the trend, false breakouts occur. Keep an eye out for them in all market conditions because they typically give obvious indications of future market direction.
2) Trading against a trend is challenging, but waiting for a strong false breakout signal from the primary support or resistance level is one of the best strategies to trade against a trend.
3) False breakouts provide us a glimpse into the battle between amateur and professional traders, allowing us to trade alongside the pros. Trading might take on new significance for you if you learn to spot and trade false breakout patterns.
False breakouts are known to increase volatility. Because assets are rushing after a breakout, the resulting volatility is likely to provoke emotion. Using the techniques outlined in this article will assist you in establishing a trading strategy that can give excellent returns while providing a manageable risk when implemented correctly.