How to Profit from False Breakouts

How to Profit from False Breakouts

Submitted by adil on Thu, 06/05/2014 - 07:35

Here's How You Profit from False Breakouts

Traders often attempt to trade breakouts but fail due to the price failing to move beyond a previous high or low, despite the prediction indicated by the trend. These failures are often very costly to unprepared traders. It is possible for diligent traders to make a profit from these breakout failures- the below contains a strategy to help traders determine when to enter the market in order to profit from a failure to breakout. The strategy is incomplete as it only provides traders with indicators to enter the market- traders will need to individually complete the strategy by determining appropriate exit points in order to make the strategy viable. It is beneficial for traders to prepare themselves to undertake learning this strategy by becoming familiar with Fibonacci’s Retracement Levels. These levels are a potential solution for needing to exit the market in order to earn a profit from a breakout failure.

Traders should begin to prepare to enter the market by isolating forex pairs (or other assets) where weak trends occur- these assets are most likely to experience false breakouts. If time permits- risk can be reduced by seeking pairs with a history of confirmed false breakouts.

A weak downtrend is identified by the price making lower swing lows and then reverse course. The chart will appear to “drift” down; a strong trend would be better described as “hammered” down. A weak downtrend is ideal for traders to purchase.

A weak uptrend is identified by the price making higher swing highs and then reversing course. The chart will be an inversion of a weak downtrend- the price will “drift”. A short position within a pair on a weak uptrend can result in a profit when played appropriately.

Once the trader has located a weak trend the former high or low points should be marked on the charting software for ease of visibility. Next, attach trend lines to the most extreme waves to indicate the new trend. When the price crosses the horizontal line (the former extreme) the trader should begin monitoring for a false breakout.

The potential false breakout is indicated when the previous extreme point is crossed and almost immediately reversed. The predicted trend line will assist in confirm if the breakout is truly false. The trader should compare the new extreme to the trend- if the price is just barely outside of the extreme and then falls back inside the trend the trader should enter a short position as the price crosses inside the trend. This sudden price shift is caused by other traders bailing as the expected price shift fails to occur.

This strategy to profit from false breakouts is generic intentionally. Individual traders have varying degrees of ability to spot weak trends and tolerate taking what instinctually appears to be an unfavorable position. One of the most useful tools for customizing this strategy is Fibonacci Retracement Levels. These levels will provide viable exit points which provide a reward greater than the risk. If the Levels are unable to provide a viable exit- skip the trade.