What Is Breakout In Trading?
A breakout refers to a price of an asset that breaks beyond a key support or a resistance level, which usually leads to huge price movements.
For example, we can place a resistance level above and a support level below if the price moves within a range.
Price as rejected multiple times towards the resistance and support levels.
Now notice that as soon as the price broke out at the key level, the market started trending; this would have been a good entry.
There are two types of breakout trading strategies,
Suppose the market has been consolidating for some and rejected many times by touching the same resistance level.
If the price key level has broken the resistance zone towards the buying side, it would be a good buying entry after the next opening.
Remember one thing: one should give an entry after the breakout candle closes above the rejected resistance, and the next candle should be open above the resistance zone.
Suppose the market has been consolidating for some and rejected many times by touching the same support level.
If the price key level has broken the support zone towards the selling side, it would be a good selling entry after the next opening.
Remember one thing: one should give an entry after the breakout candle closes below the rejected support, and the next candle should be open below the support zone.
How to find this type of breakout trading strategy?
There is a simple way to do that by looking out the breakout patterns.
I am sure that most of these patterns you have seen before.
Patterns like Rectangle, pennant, wedge, triangle, flag, all such types of ways for trading in a breakout trading strategy
When looking at this pattern list, traders make a common mistake because they wait for the market to make the same movements as the drawings.
For example, they look at the wedge pattern, and they will try to find candles that move the same as this.
If you are still doing this, I can guarantee that you will never spot a single pattern because the truth is that prices don’t move like this in real life.
So instead, what you want to focus on, is to find the key levels.
For example, as we look at this chart, we can see that the price is forming lower highs, which means we can draw a downward straight line above it because there are multiple rejections.
As we look below the chart, we saw more rejections, and so we draw a support line below here; now, if you look closely, we just found a triangle pattern because we have the same key levels, a downward trend line, and a support line.
So this concept applies to other patterns as well.
If you spot a support and resistance level, and then it’s a rectangle pattern.
If you spot two opposite trend lines, it’s a pennant.
If you find two trend lines heading in the same direction, it’s a flag pattern.
By knowing this key concept, you don’t need to memorize the name of patterns; it doesn’t matter if it is a triangle, a wedge, and Rectangle; at the end of the day, all of them are on one concept.
- Price consolidations
- Forms key levels
As long as you would find these key levels, ou strategy would work more accurately.
Once you identify this consolidation pattern, the next step is predicting the direction of the breakout, and it will happen to the upside or the downside.
The traders’ common mistake is that they immediately take a position at the first breakout that they see.
For example, here we spotted both a level of support and resistance, which means it is a rectangle pattern, so next, we can see the candle closes slightly above the upper level, now traders will think, this is the breakout, and movement will happen to the upside, and they will make an entry.
They will lose money because the breakout will not happen, and the price is in the consolidation range.
How to Avoid False Breakout In Trading?
While I use it to avoid false breakout trading, a simple trick is to identify the momentum candles at the time of breaking.
A momentum candle could be in the form of a big candle or multiple medium-sized candles.
For example, in this chart, we can see the price is forming lower highs, which means we can draw a downwards trend line above here, and below it, we spotted higher lows, so we draw an upper trend line.
It is a pennants pattern.
When the big green candle broke the upper trend line by a small part, as shown in the picture, do not enter the trade blindly and lose money.
Wait for the next candle to form; if it is the big or medium momentum candle, you can make an entry trade.
But unfortunately, it was the red candle that formed instead, so we ignore this trade and wait for the momentum green candle to form.
The following three scenarios will occur after the momentum candle has formed.
The price continues to trend upwards
price makes a pullback towards the key level before continuing upwards.
The price reverses downwards, and that is considered a false breakout.
How to Avoid the above scenarios?
Instead of predicting what will happen next, I am positioning myself to have the edge, no matter what happens.
What I do is, I will enter the buying position at the momentum candle close.
I will adjust my position based on the risk-reward ratio in the breakout trading strategy.
I will set my stop-loss slightly below the upper trend line to benefit from every scenario.
If the first scenario happens, that means the price continued upwards, and I will end up being profitable.
If the second scenario happens, if the price pullbacks towards the key level before continuing upwards, the stop loss would not be hit, I will still end up in profits.
Unfortunately, if the third scenario happens, it is a false breakout; my stop loss will get hit, preventing me from losing more money.
What Is The Target In Breakout Trading Strategy?
Target should be according to your risk to reward ratio.
I would suggest trailing stop loss because breakouts will occur in a huge range in breakout trading.
For example, if I had made an entry with two lots, if the stock has moved up to the 1:1 ratio, I will close one lot position, I will ride the trade with one lot up to 1:2, and I will shift my stop loss up to my entry price.
Risk management is important in breakout trading strategy.
All the above cases discussed are all probabilities; there are no sure shot points in the stock market.
I may confidently say that if you follow the above rules, you can get the most accurate trade-in breakout trading strategy.
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