| Breakouts are one of the easiest technical patterns | | | | False Breakouts (Fakeouts) |
| to spot. They occur in all instruments and in all time | | | | Not all breakouts follow through. Sometimes the price |
| frames, so it doesn't matter if you're swing trading a | | | | will dip below support (or pop through resistance) |
| currency, or day trading a futures contract, | | | | only to turn around and go back within the previous |
| breakouts are a pattern you can trade. | | | | trading range. This is more prone to happening with |
| What Is A Breakout? | | | | certain instruments where market makers or big |
| Before we look at trading breakouts in more detail, | | | | players can control price to a certain degree. |
| we should first answer the question, what is a | | | | For example, let's imagine a market maker wanting to |
| breakout? To understand breakouts, first it's | | | | buy a large quantity of stock. Naturally, he wants to |
| necessary to understand support and resistance - the | | | | get it at the best price he can. The stock is currently |
| basis of all technical analysis. | | | | trading within a range. The market maker already has |
| Put simply, support is the point at which enough | | | | a chunk of stock, and he sells this off, his relatively |
| buyers come into a market to arrest a drop in price. | | | | large selling forcing the price through the support |
| Conversely, resistance is the point at which enough | | | | level. As the price of the stock drops, a number of |
| sellers enter a market that the price stops rising. | | | | short-sellers enter the market, selling on the breakout |
| If buyers enter a market at a certain price, stopping | | | | expecting momentum to carry the price further |
| the fall, and the price rises then subsequently falls, | | | | down. The market maker starts buying up all this |
| the price will once again reach the point of previous | | | | stock that the shorts are selling, getting it for a |
| support. At this moment, the support is said to be | | | | bargain price. As the sellers run dry, the price is |
| being 'tested'. If the buyers re-enter the market at | | | | forced back up, and as it does so, the short sellers |
| (or close to) the same price as before, thus pushing | | | | stops start getting hit and they are forced to cover |
| the price back up again, we can say that support has | | | | their positions by buying back stock. All this buying |
| held. The support price point now has more strength | | | | activity pushes the price even higher! |
| than before, because it has been tested twice. | | | | When a breakout is manipulated in this way, it is |
| If the price bounces from the support point | | | | usually referred to as a 'fakeout'. |
| repeatedly, that support becomes stronger and | | | | Safe Breakout Trading |
| stronger. In a sort of 'self fulfilling prophecy', new | | | | So if a trader can't be sure if a breakout is going to |
| buyers will often come into the market near previous | | | | follow through or not, should they even attempt to |
| support in the hope that the price will once again | | | | trade them? How can we take advantage of this |
| bounce and rise, thus making the support hold again. | | | | seemingly simple, but deceptively devious, trading |
| Eventually however, the support will fail and the price | | | | pattern? |
| will drop through. This is a breakout - so-called | | | | One way is to carefully choose the instrument we |
| because the price has broken out of the range in | | | | trade. Forex for example, is less prone to fakeouts |
| which it was trapped, between support and | | | | because the market is so huge that it is almost |
| resistance. | | | | impossible for any individual or institution to |
| When a breakout occurs, it will often do so with such | | | | manipulate false breakouts. |
| force that the price will carry on dropping (or rising, it | | | | Another way is to use advanced trading tools like |
| the breakout was to the upside - that is a break of | | | | Level 2, which gives complete market transparency |
| resistance). To understand why, consider all those | | | | and therefore lets the trader see what's really driving |
| buyers who were buying at the support line. | | | | price. |
| Eventually there are not enough of them left to prop | | | | But perhaps the most effective way is simply to |
| up the price, and so it falls below support (in other | | | | become a student of 'momentum', or tape reading. If |
| words, it breaks out). Some buyers who had bought | | | | you can learn to read the tape (the Time & |
| at that price point will immediately cut their losses | | | | Sales screen, which reports trades in real time), you |
| and sell. This pushes the price down further. As the | | | | can quickly learn to spot true momentum and real |
| price drops, more and more buyers who had | | | | breakouts. |
| purchased at support will hit their stops, triggering | | | | Conclusion |
| yet more selling. | | | | Breakout trading is a relatively high probability low risk |
| This vicious circle of selling causes 'momentum' and | | | | way to trade. As with any trading pattern, breakouts |
| the price spirals downwards. | | | | will work some of the time, and will fail other times. |
| After all, if we sold when the price broke-out to the | | | | With practice, and by learning to read momentum, a |
| downside, or bought when it broke-out to the upside, | | | | skilled trader can quickly learn to spot the best |
| we could just sit back and enjoy the ride, right? Well, | | | | breakout opportunities. |
| not quite... | | | | |