Breakout trading is a technical trading system breakout forex indicator. The rationale behind it is simple.
It involves trading in the direction of newly forming trends. This means entering long when the price breaks-out above an established resistance level, and entering short when it breaks below an established support level. Many breakout traders also use opportunities when the price breaks-out of any type of trading pattern. This can be a triangle, a head-and-shoulders pattern, a flag, a box channel as well as the more common support and resistance levels.
This type of style seems counter-intuitive to a fundamental trader. A fundamentalist’s goal is to buy below fair value, and sell above. The idea of buying as the price makes new highs, or selling as it reaches new lows, as breakout trading does, goes against this viewpoint. Despite this, technicals are influential in the near-term and breakout strategies that exploit them can be highly profitable. It is easy to grasp and is a quick win strategy that can lead to high profits.
The breakout trader aims to be in at the beginning of these powerful trends. Breakout events are extremely common in Forex charts. They also occur across different time frames. Nevertheless, having a good grasp of technical analysis is necessary to identify which of these are worth trading and which are best avoided. Most breakout traders use a combination of other inputs to form their decision. However, in the end, it often comes down to experience and gut instinct. The occurrence of false breaks also makes timing decisions difficult.
With a false break, the price breaks out of a range temporarily, only to pull back again shortly afterwards. This is frustrating to the breakout trader, and several runs in succession can wipe out hard won profits. Even more maddening is when you exit the breakout trade on a retracement, only for the price to double back again in the breakout direction. These kinds of retracements are what thwart the breakout traders strategy. To counter these situations some breakout traders wait for the previous level to retest before entering the trade. They wait until the price reverses and retests the boundary at least once. This is shown in Figure 2.
A successful re-test on the downside suggests the previous resistance has become a new support. Conversely, a successful re-test on the upside suggests the previous support has become a new resistance. This is because the second move suggests there is genuine momentum driven by real supply or demand. Using it means the trader enters breaks that have a higher probability of success. On the downside, it does mean capturing less of the move because of the delay on commitment to trade. It is always good practice to check key support and resistance levels by looking at the chart in several time frames. There are two reasons why false breaks happen so often.