Hi All,
Found a nice article on www.tradeceity.com
How to trade breakouts – things to look for in a successful breakout
Markets spend a lot of time ranging. Knowing how to spot and identify a successful breakout can help a trader find good trading opportunities and stay away from fake breakouts and low probability trades. There are a handful of clues and things to look for in a potential breakout that can signal whether a breakout is going to be successful or not.
Look for tight range with low volatility and increasing momentum
A tight range is typically the prelude to a new trend. During a long and narrow range, such as the one on the AUD/USD in the screenshot below, there is a lot of position building and trend-preparation going on inside. It is obvious that price touched the upper boundary many times, but failed to break; this is clue number one.
The low volatility (ATR) indicates that there wasn’t a big fight between buyers and sellers going on inside the range. A low volatility range environment usually makes for cleaner breakouts; this is clue number two.
During the ranging period, the RSI hovered in the middle which means a lack of momentum. Just before the breakout occurred, momentum started picking up and the RSI started to go down faster – clue number three.
On the actual breakout, you could only see bearish candles and the size of the candles increased as well. There was little to no opposition from the bullish side during the actual breakout. Such a breakout is likely to succeed because it shows the strong imbalance between sellers and buyers; final clue.
A trend change: sell-off, consolidation, rally
The next screenshot shows a different type of breakout. After a sell-off, price started to consolidate. This range is very different than the previous one and you can see a lot of volatility on the ATR; the candles have long wicks which signals the strong fight between bulls and bears.
Before the breakout to the upside occurred, price moved to the lower side of the range but failed to break it; clue number one.
Just before the breakout, price started to show bullish candles exclusively and momentum on the RSI started to pick up; clue number two.
The break of the moving average was a Doji candle and price closed above the moving average afterwards; clue number three. There was a little consolidation after the large bullish candle, but price never moved against the breakout.
Consolidation breakout in a trend
The third type of breakout can be found during trends. After a trend leg, price often spends some time ranging and consolidating. Such periods often offer great re-entry opportunities if a trader knows what to look for.
The screenshot below shows an uptrend of Tesla. First, it’s important to see that the consolidation happened after a pullback, but it never made a lower low. It even tested the prior highs as support – clue number one.
Prior to the breakout, price started to move up very slowly and eventually broke the moving average. At one time, price gapped and opened below the moving average, but buyers pushed it back up immediately – clue number two.
Momentum picked up before the breakout happened and the RSI started rising again –clue number three. Eventually, the previous high broke in a strong fashion and price kept on making higher highs. The consolidation during the pullback could have been a good time to add to an existing position or to establish a new position.
Trapped traders
It is always important to understand where traders will be trapped in losing positions to identify profitable trading opportunities. The screenshot below shows such an example. Price ranged for some time and then suddenly started to move lower. It broke the moving average to the downside and also started to show downside momentum in the RSI. However, at this stage, no actual breakout had occurred and price was still in the range. Traders who anticipated a breakout had entered already, whereas the professionals saw that the range was still intact.
Then the large bullish candle happened and all short positioned traders were trapped. The next candle opened with a breakaway gap beyond the resistance area. At this time, momentum had shifted and the RSI had moved higher.
This example shows that waiting for the actual breakout has to be the #1 priority during a range market. Amateurs try to predict breakouts too often and then get caught in losing positions.
How to trade breakouts – recap
Knowing how to trade breakout is an important skill in trading because breakouts typically occur at the origin of a new trend. Not knowing how to trade breakouts, though, is what leads to disaster for amateur traders. Here are the most important things to look for in a breakout:
- Waiting for the actual breakout to happen is the most important factor.
- Rising momentum on the breakout is essential
- Previous failed breakouts to the opposite site of the range can tell a lot
- A break of a moving average can be another criteria
- Look for fake breakouts and areas where amateurs are likely to get trapped
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