How to Trade a Breakout in Forex
What are breakouts?
One of the simplest Forex trading strategies that both new and experienced traders look to use is known as breakouts.
Break out meaning: Simply put, breakouts are the price of an instrument moving beyond a range of consolidating and moving into a new range whether that be at a higher or lower valuation.
In trading, a lot of speculators will look to buy if the markets breakout above the current range, or sell when the markets go below the current range. We detail these ranges and trading channels below.
How to Trade a Breakout
Often a breakout strategy is combined with chart pattern analysis. The markets often repeat themselves and create patterns that are predictable to trade. Breakouts from those channels are what we will look at below.
Trade a Support Breakout
A support point is usually viewed as a floor in the price of the market. As you can see from the yellow rectangles, each time that the price touches the floor we frequently see an upwards move.
The opportunity for a break out will come when the markets no longer trade at that level, but escape that “floor” and go into a new price range. See the example below. The beak out takes place in the blue channel.
Trade a Resistance Breakout
A resistance point is usually viewed as a ceiling on the price of the market. As you can see from the yellow rectangles, each time that the price touches the ceiling, we frequently see a downwards move soon after.
The opportunity for a break out in the resistance will come when the markets no longer trade at the level of the ceiling but escape into a new price range. See the example below. The break out takes place in the blue channel.
Where is the entry point of a breakout?
The entry point for a break out as per the above is usually directly above or below the trend channel you have spotted. Each trend or channel will usually give you the direction of either long or short, buy or sell, and your entry should be placed in the direction you wish the break out takes place. Breakouts aren’t always correct, however.
In a bull or buying market – the breakout will be above. Entering at the red arrow.
In a bear or selling market – the breakout will be below. Entering at the red arrow.
Where to put a stop loss in a breakout?
The stop loss level for a breakout is determined by the direction you wish the markets take.
If selling and hoping for a breakout of the floor, you may have your stop loss at resistance. See below. You want to enter at the red arrow, but the market goes against you, the red cross is your stop loss, as if the markets pass this, you may fear a break out in the opposing direction to your entry.
If buying and hoping for a breakout of the ceiling, you may have your stop loss at support. See below. You want to enter at the red arrow, but the market goes against you, the red cross is your stop loss.
What is a False Breakout?
False breakout occurs when the markets may appear to be heading for the above or below move you expect, but after starting to go in that direction, change course and start to head in an opposite direction. This is why having a stop loss as per the above is vital.
The yellow are all examples of false breakouts.
Best Brokers for Breakout Trading
The best brokers for breakout trading are usually those who allow news trading, having low spreads, good execution speeds and generally reliable. Trading breakouts can be one of the riskiest areas to place a trade, so brokers would need to offer the above and more, to help ease your mind when trading with them.
Here is our list of the best brokers for breakout trading:
What Are Breakouts Best Used For?
In spotting the momentum of the markets and seeing any channel, a trader would want to anticipate the areas where they believe the chances of a breakout exists. In such trends there is usually a high level of uncertainty, meaning that although the markets may be trending, they are usually low in any real, rapid price movement which means it’s harder for a trader to profit.
As you can see below, those who anticipated the breakout below would see more profitable opportunities than those trading within channels
What Is a Breakout Stock?
In stock, breakouts are common but referred to as gaps. Gaps occur when the markets close and re-open at a different level to the close price. These occur as there may have been big news leading to a drastic change in price.
Within the chart below we have 2 examples of gaps. Above and below the support and resistance.
News release breakouts
News releases are part of the fundamental analysis side of trading. News releases could be anything from a company announcing its earnings to, a country reporting a change in interest rates, to GDP data. Although these are a fundamental way of trading, they do impact markets trading breakouts. Here are several ways how.
- Volatility
In times of high impact news release, we see the level of market uncertainty greatly increases the chances of a previous streak of consolidation to end and move into new price ranges.
2. Temporary breakouts
When news releases occur, we often see the shorter time frame charts react first, and as a result, some breakouts are only temporary. Most traders like looking toward 4 hours and above charts for sustained breakouts, however when news comes out, you could see a breakout in the 30-minute timeframe and below, however, this will only last momentarily so traders must take advantage quickly.
Pros and Cons of Breakouts
Pros:
- Tries to capture a new direction
- High reward possibilities
- Signal the end of uncertainty/market consolidation
Cons:
- False breakouts
- High-risk areas
- Highest chances of incorrect moves, then correct
Combining Breakouts with other Strategies
Any trading indicator should not be used as a standalone. The best traders often combining a range of tools to form an overall strategy. Although when using the breakout system, it is tempting to only use an entry order above or below support and resistance, that will not be a perfectly executed trade.
Here is a list of other trading strategies you can use alongside breakouts.
Other Trading Strategies: