Forex Trading Breakout Strategy Full Explain, By Forex Forum.
Before we get into my favorite Forex breakout strategy, let's first define the term, "breakout".
A breakout is any price movement outside a defined support or resistance area. The breakout can occur at a horizontal level or a diagonal level, depending on the price action pattern.
We have a market that is trending up but has found resistance at a horizontal level. After two unsuccessful attempts, the market finally breaks through resistance. This signals a bullish breakout from a key resistance level.
So, what is a support level?
If you're using technical analysis for your trading, looking at a chart over a period of time will show some support levels – areas or specific levels where prices are usually supported.
Support levels provide what is called a 'floor' for prices. This means prices usually stay on this level because it has the support (of buyers).
And what is a resistance level?
A resistance level is the opposite of a support level.
Looking at a chart, you can find resistance levels – which are areas or levels where prices are usually stopped (resisted) and can't go any higher for a period of time.
Why Trade Forex Breakouts?
Breakout trading setups in Forex can provide nice trading opportunities. The reason for this is that breakouts often lead to new price moves and trends. In this manner, traders attempt to enter the market right when a breakout occurs in order to get in early on a potential emerging trend.
In addition, many of the more reliable breakouts tend to occur on high momentum, and price action traders attempt to maximize their profit from the rapid price moves. Breakout trading is a simple and popular trading technique used by many Forex traders for good reason.
Types of Breakouts
Breakouts can be categorised further into continuous, reversal or false breakouts. Something that all breakouts usually have in common is they occur after a period of consolidation, during which traders pause to consider their next actions.
1. Immediate Breakout
2. Pullback Breakout
3. False Breakouts
An immediate breakout occurs when the price manages to break a support or resistance immediately with no pullback or retracement before continuing its main direction.
The pair moves quickly in this scenario, so the trader must also act swiftly. It is the most profitable scenario among the three.
An immediate breakout gives the chance for traders to put a tight stop loss but for sure with high probability to be triggered.
After seeing the immediate breakout, it is time to introduce you to pullback breakout.
Pullback breakout is safer version of the immediate breakout. It is recommended to beginners since it gives a confirmation before the price makes its move. This scenario of breakout will be noticed when the price breaks a support or resistance, and then it makes a pullback or a rebound to the previous support or resistance before continuing its main direction.
The third scenario you might face is the false breakout. This happens when the price breaks a certain level, but it fails to stay above or below it and does not continue its direction.
As we all know there is nothing perfect in markets, so you should always expect these types of movements. That is why it is advisable to always use a stop loss in your trades.
Forex Breakout Strategies
While there are many types of forex breakout strategies you can classify breakout trades into two broad categories:
1. The momentum breakout setup
2. The breakout pullback setup
How to Identify a Breakout in forex trading?
Breakouts are usually triggered by fundamental forces – an economic data release or event. Nevertheless, technically, the stronger breakouts appear above or below established channels and price patterns.
Patterns which show the most well-defined breakouts include head and shoulder patterns, double tops and bottoms, wedges, flags, pennants, rectangles and triangle formations. Perhaps the most common breakouts are those that occur through an established channel.
Bollinger Bands are a technical indicator used to display areas of support and resistance on a price chart. They provide a visual representation of a breakout, as when prices reach the outer lines of the bands they often continue moving in the same direction, beyond the resistance or support lines.
Exponential Moving Averages
Exponential Moving Averages (EMAs) are another indicator that can be used to trade Forex breakouts. By combining the 5, 30 and 50 period EMAs, you can pinpoint an upcoming breakout when the indicators flatten out. Once the shorter-term EMA breakout out from the established narrow range, it's likely that an overall breakout will occur in the same direction.
The Best Breakout Trading Strategy
1. Identify a clear price range or a "V" shape swing high and mark that price level on the chart.
The first step of the best breakout trading strategy requires identifying the price level. It can ultimately be your breakout trading level. This is the most important part when attempting breakout trading. This is why we only want to recognize significant and clear levels.
Do you want to boost your knowledge in identifying these levels? We recommend spending 5 minutes to read, Support and Resistance: What Is Going On at These Critical Areas. This article will teach you methods to help identify the right support and resistance level.
2. A reduction in the reactions (or pullbacks from that support/resistance level)
Why does a reduction in the pullback from a key support or resistance level help your breakout trades?
Let's say the market is in a bull trend and it's encountering a resistance level where there are likely bears with offers up at that level. If the bulls hit the resistance level the first time, and the market pulls back say 50 pips, then when the 2nd time the price action hits that resistance level, the market only pulls back say 25 pips, this indicates a weaker reaction by the bears at the level.
3. Wait for a break and a close above the resistance level
Once the resistance level has been identified from there on, it's just a game of patience and waiting.
We need a breakout and breakout candle to close above our resistance level. This is a sign that the bulls are in control.
4. Buy at the breakout candle closing price only if the VWMA is stretching up.
The final step of the best breakout trading strategy is the needed confirmation from the VWMA. We need to visually see the VWMA stretch up. And the moving average needs to have a deeper inclination to the upside.
This can be clearly visualized on the price chart. Prior to the breakout, the VWMA only gradually moved higher after the breakout happened. We saw the VWMA aggressively moving higher, which showed a strong presence of volume behind the breakout.
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How to use a breakout entry in your trading?
One way of using the breakout entry is to get into a trade when the price has breached a resistance level. For many traders, a breach of the resistance level means the price has the momentum to go higher.
The thinking behind this is a breach of resistance can mean traders are bullish and will support the price move to a higher level.
While this may not always be the case, many traders use this breakout from a resistance level as an entry point.
On the flipside, you can use the breakout entry when the price has breached a support level. A break of support is usually seen as a signal that prices may go down further. Some traders use this breach of support to take advantage of falls in prices.
Knowing what support and resistance levels are and how you can use them to identify when prices are breaking out of these levels, you can use this entry strategy for your trading.
While breakouts offer more guidance on when to enter the markets, it is also important to know when to exit a position with a profit (as well as with a loss). Target price levels could be placed using the recent price action and some significant levels (support and resistance levels). The average of recent price swings can also be used to determine a reasonable price objective. With most chart patterns, there is also a way to determine the target price.
For example, when prices break the neckline of a head and shoulder pattern, just take the same distance as the one found at the top of the head to the neckline, and report it from the neckline breakout. This should provide a profitable exit point.
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