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:
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
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
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.
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.