Hey traders, hope everything is going well.
As you already know, I’m writing a series of articles with details about my trading strategy…
Here are the links to the previous ones:
And this one is the fourth one…
But in order to understand what you are going to read today, you need to make sure to at least give the other articles a quick read ok?
I’ll wait… I promise this article is not going anywhere.
How to avoid False Breakouts
Many traders are actually afraid of taking breakout trades because of they are afraid of being caught in a false breakout.
And I understand that, its not a very pleasant experience to take a breakout trade, and see the market turn around just as it reached your entry level.
No body likes that!
But you need to learn to minimize that possibility and that’s what you are going to learn today.
Now, don’t get me wrong, there is no absolute way to get rid of losing trades, once in a while you are going to get caught in a false breakout, that’s just part of trading, but if you apply what you are about to learn here, I promise that you’ll reduce them to a minimum.
The idea is simple, take breakouts only in the direction of the market condition.
What does that mean?
From the previous article you know there are 4 types of market conditions right?
So, for each market condition:
- When you are in bullish condition, you are only going to take long breakout trades
- When you are in a bearish condition, you are only going to take short breakout trades
- You are not going to trade any breakout when the market is trading near an important LT level
- You are not going to take any breakout trade when there are no clear market conditions.
- I always use entry stop orders to get into breakout trades.
- Set my entry order from 15 to 25 pips above the highest high for longs (or lowest low for shorts).
- Set my SL from 15 to 30 pips below the short term support (previously a resistance level) for longs (or above the short term resistance level (previously a support level) for shorts). For currency pairs that move faster, you can play safer by placing your SL around the middle of the range.
That simple my friend!
How to take profitable breakout signals
Remember the market dynamics image?
Ok, here it is again:
Did you understand that image? Its very very important…
Ok, here is a simple explanation.
When the market is at the bottom, it is trading near an important LT level (blue line). At that point, we still don’t know whether the market is going up or down (we are on the third market condition here).
So we wait.
At this point we don’t take breakout trades, because it is where the market is most volatile. Do you know why?
Do you know whats happening when the market trades near an important LT level?
There is a fierce battle between buyers and sellers, and of course, each groups wants tho be the winner. And what do they do?
They try to push the market to the limits (sometimes outside of that range), just to see if there are a good amount of traders from the other group, on the other extreme. If there are enough traders from the other group on the other extreme, the market will bounce back, and will constitute what we all fear: a false breakout.
And of course, if there are no enough traders, we’ll have a valid breakout, and that’s when the market condition gets triggered (market condition, not a breakout signal).
Only then, is when we start looking for trade opportunities.
So here is that image, with a few annotations about when to take those breakout trades.
We are not allowed to trade any breakout trades around the red boxes, why? because of the same reasons, there is a fierce battle between buyers and sellers and and most false breakouts appear around those zones.
A big part to avoiding false breakouts is knowing when to take those trades.
Rules to trade breakout signals
As traders, we need to have rules for everything, we need to take every trading decision beforehand, because at the heat of the moment, we are not likely to take those decisions based on out best interests.
Ok, with that being said!
The rules that I follow to take breakout trades are:
Because each instrument is different you need to use a different levels for each instrument. You cant treat all instruments in the exact same way, that would be a terrible mistake.
Some of those instruments move a pretty fast, so you need to use wider stops, entries, etc. Like the GBPAUD for instance… And some other move pretty slow, so you don’t need that wide orders and SL levels, like the AUDUSD.
Remember its not about placing your entry 15 to 25 pips above the resistance level, because everyone draws it at a different level.
Your entry should always be placed from 15 to 25 pips above the highest high. In this case we could easily use 20 pips above that level, because we are talking about the GBPAUD, and it moves fast.
Your SL should be placed at least 30 pips below the support level or, since its a real mover, you can play safer by placing it around the middle of the range.
Now, the take profit order is different form trader to trader. I like to capture the complete swing, so I use LT levels to set them, if you are a day trader, you might want to close your trade at the end of the day, but I recommend you to use at least a 2:1 risk reward ratio on all your trades.
Do you take breakout signals?
What do you think about the methodology I use to take breakout trades?
How do you avoid taking false breakouts?