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Trading Breakouts in FX market, by Sam Shenker

  • Post #1
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  • First Post: Edited Jun 30, 2006 7:00am Mar 3, 2006 5:18pm | Edited Jun 30, 2006 7:00am
  •  FX Articles
  • Joined Feb 2006 | Status: Member | 313 Posts
Breakout trading is one of the most alluring trading strategies that draw beginners and professionals alike. Breakouts are a much sought after setup because a successful breakout creates a high risk/reward opportunity that has the potential advantage of a large price move. A successful breakout is extremely hard to come by and most of the times traders find themselves in a situation that is referred to as a “fakeout” or otherwise known as a whipsaw.

A breakout setup is not as straight forward as it used to be due to the advent of trading technology, communications and high number of participants in the market reacting to a potential breakout at the same time. As markets constantly evolve so do the trading setups and many seasoned traders are aware that what worked previously may not work in the future. As a trader I look for opportunities where we have a pattern breakout combined with either a higher high or lower low close depending upon the direction of the breakout.


What I look for:

1. Pattern Breakout

2. HH (Higher High) / LL (Lower Low) Momentum Breakout

3. Potential Target = Distance between top and bottom of the consolidation range


A word of caution for the potential breakout players
: a breakout trader must keep in mind the timeframe he or she is trading on, as lower timeframes will have a higher number of potential breakouts, but also a higher number of failures. Also a trader must keep in mind that the profit potential will be different for different pairs and different timeframes, the higher the timeframe the higher profit potential, but on the flipside the higher the potential loss if the breakout turns into a fakeout.


Pattern Breakouts

Pattern breakouts are the most common form of breakouts as it is based on the pure price action and a breakout from the reversal/consolidation patterns. The most common patterns consist of triangles, channels, wedges, pennants, flags and less common, but still potent Head and Shoulders patterns.


Triangle

Triangles are the most common type of a price pattern that can be found on virtually any chart and timeframe. A common rule for trading triangles is as follows: as the range shrinks and becomes tighter, the further the subsequent breakout will travel, which will reduce the chance of a fakeout or whipsaw.


EURUSD

http://www.forexfactory.com/pics/articles/ss1.JPG



The chart above is a perfect example of a pattern breakout in which we see the EUR/USD break below the consolidation triangle on the daily chart. This particular setup calls for entry after the candle closed at 1.2667 with stop placed above the major swing high at 1.3077. Profit target is projected using distance between the top and bottom of the consolidation range, which in this case is 1.2066, translating into 600 pips, thus giving the strategy a 1.5 to 1 risk reward.


NZDUSD

http://www.forexfactory.com/pics/articles/ss2.JPG



Here is an example of a successful double breakdown where a triangle breakout was preceded by the breakout from the wedge pattern. New Zealand dollar signaled weakness after the pair broke below the wedge’s lower boundary, giving the trader an entry around .7035 with the protective stop placed above .7126. Additional entry appeared after the pair broke below the triangle’s lower boundary at .6944 with the profit target set at .6780, a 78.6 Fib retracement, as most swings tend to stall around key Fibonacci levels.


  • Post #2
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  • Edited May 27, 2006 2:24pm Mar 3, 2006 5:32pm | Edited May 27, 2006 2:24pm
  •  FX Articles
  • Joined Feb 2006 | Status: Member | 313 Posts

http://www.forexfactory.com/pics/articles/ss3.JPG


Another common pattern found on the chart and especially in the currency market is the price channel, were small price fluctuations create a pattern that resembles a channel. Channel breakouts can lead to a development of another channel as we can clearly see from the above chart how AUD/NZD broke above the downward sloping channel and subsequently established an upward sloping channel.


Let us go through the trade example. AUDNZD remained confined to a downward sloping channel that dominated the cross from September until a breakout in early December. As soon as the price closed above the channel’s upper boundary at 1.0655, trader enters the trade at 1.0655 with the stop below the swing low at 1.0441. Profit target is set at 1.0998, using the 78.6 Fibonacci retracement of the previous rally, thus giving this particular trade a risk reward of 1.60 to 1.


Higher High/Lower Low Momentum Breakout

As nature of breakouts changed, especially short-term breakouts, with higher number of fakeouts dominating the price action, I have developed a new breakout strategy with higher probability of producing a successful trade. I dubbed the strategy a momentum breakout.

Momentum breakout is a short-term trading strategy where I enter the trade following the break below the low or the high, depending which side of the market I’m trading at the time, of the fakeout. Yes it’s a strategy to counter fakeouts as most of the time trader will most likely be on the side of the momentum after the momentum breakout takes place.


Example:

Following is a great example of recent price action as it encompasses breakout, fakeout and a momentum breakout, which took place in GBP/USD during September of 2005, with the complete setup broken down by days as trade progressed.


Setup:

British pound was trading within a channel and broke below, but failed to sustain the initial momentum and turned into a fakeout that subsequently turned into a momentum breakout.


Day 1

http://www.forexfactory.com/pics/articles/ss4.JPG


British pound daily chart has the GBP/USD trading within a large channel, with the last swing to the downside encountering the channel’s lower boundary. Here is the dilemma facing most traders, do I swing the price the other way, or will the price breakout and head lower. Most traders will trade in anticipation of either setup. My trading tactic is to wait and observe the price behavior, if the price flashes a turnaround than I will swing for the channel’s upper boundary, if the price flashes a potential breakout than I will trade in the direction of a breakout.


Day 2

http://www.forexfactory.com/pics/articles/ss5.JPG



Next day showed the indecision from both sides with the price closing at the channel’s lower boundary, the best thing to do during the days of indecision is to remain on sidelines, because trading is not about guessing.


Day 3

http://www.forexfactory.com/pics/articles/ss6.JPG


Following day the price opens below the channels and slowly moves to the downside. The breakout is far from decisive and lacks momentum showing there is a potential for a fakeout.
 
 
  • Post #3
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  • Edited May 27, 2006 2:23pm Mar 3, 2006 5:36pm | Edited May 27, 2006 2:23pm
  •  FX Articles
  • Joined Feb 2006 | Status: Member | 313 Posts
Day 4 and Day 5 (Fakeout Setup)

http://www.forexfactory.com/pics/articles/ss7.JPG



Day 4 shows that breakout lacks “conviction” with the pair failing to break below the low of Day 3. Day 5 sees the price completely reverse direction and stage a sharp rally toward the channel’s upper boundary, thus causing a whipsaw and creating a fakeout scenario.



Day 6

http://www.forexfactory.com/pics/articles/ss8.JPG


Day 6 brings a surprise to the market with British Pound collapsing during a sudden sell off after the pair failed to climb back into the channel. This particular setup that occurs frequently where the channel is reinforced after the price returns and continues to trade within a channel. From the chart above we can observe a break below the short-term range low established during Day 3, 4, 5. As the price breaks below the low, trader enters upon the close of the candle at 1.7903, with the stop placed above the swing high at 1.8161 and profit target at 1.7513, a 78.6 Fibonacci retracement.


Day 7 through 13

http://www.forexfactory.com/pics/articles/ss9.JPG


As trade developed we saw the pair collapse through the rest of September until GBP/USD hit the profit target established by the 78.6 Fibonacci retracement at 1.7513, with the trade netting 360 pips, thus giving the trade a 1.4 to 1 risk/reward.


In conclusion I would like to add that breakout trading is rewarding as demonstrated by the number of previous examples, but trading breakouts is hard work and a trader should expect a high number of failures before he or she can find a valid breakout. Momentum breakouts can reduce the probability of being whipsawed, but as with any strategy, it’s not 100 percent accurate and should be treated as any other trading setup.

My final advice to the reader is to use protective stops especially when trading pattern breakouts, don’t be proud, I use stops, and so is every professional trader I know. Remember there are no certainties in the market.
 
 
  • Post #4
  • Quote
  • Edited May 27, 2006 2:22pm Mar 3, 2006 5:41pm | Edited May 27, 2006 2:22pm
  •  FX Articles
  • Joined Feb 2006 | Status: Member | 313 Posts
Sam Shenker is a Technical Currency Analyst for Forex Capital Markets (FXCM). Sam is the author of the Daily and Weekly Technical Research reports at FXCM.

His reports include: Daily Technicals, Weekly Crosses and the Weekly Futures Commitment of Traders Report. Prior to joining FXCM, Sam spent a number of years on Wall St and has traded many different products, including: equities, equity derivatives and futures.

He also specialized in research and analysis of high yield bonds, corporate bankruptcies, restructurings, reorganizations and venture capital.

He holds a Bachelors degree in Finance and Business Management from Pace University and is an active currency trader. Sam is frequently quoted on FXStreet.


http://www.forexfactory.com/pics/articles/Sam.JPG

 
 
  • Post #5
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  • Jul 18, 2009 12:35am Jul 18, 2009 12:35am
  •  basilios
  • | Joined Jul 2009 | Status: Member | 1 Post
Hi,

Your article is very good. But unfortunately I can't find out the chart you mentioned on your article. It is very helpful if the chart is available.

Regards,
basilios
 
 
  • Post #6
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  • Last Post: Nov 14, 2009 4:30pm Nov 14, 2009 4:30pm
  •  Kipcashf
  • | Joined Sep 2009 | Status: Junior Member | 1 Post
Please try to get some charts in this thing to aid understanding
 
 
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