False Breakout Strategy

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Video Transcription:

Hey, traders. Welcome to Video 14 of the Advanced Forex Strategies Course. This is Cory Mitchell. In this video, we are talking about capitalizing on false breakouts. So many traders love to trade breakouts. A lot of times they don’t work out. We’re going to figure out how to profit by that in this video. We can use it on all timeframes. Brought to you by Investoo.com.

So trend trading is where the money is. Even though we’re going to be looking at more some range-type strategies today, we are going to still be focusing on capturing these likely shorter-term trends. Still want to trade those, even though we’re within more of a ranging-like structure.

So by highlighting strong support or resistance areas — we covered those in the last video, and we’ll go over them again here today — we can spot high probability entries for uptrends and downtrends, respectively.

So, as mentioned, we will look for entry points around those strong areas. And occasionally the price will break it and quickly reverse.

These are typically low risk, high profit potential trades. Can be used on all time frames, but we do want to be aware of what is happening on large time frames.

Also, if you’re trading these on a one minute chart, or something like that, you have to really watch to make sure that the range is actually big enough to make enough of a profit from based on the spread. Let’s say you’re trading with a one or two pip spread, or a three pip spread. You have to really watch to make sure that range is going to give you enough room to make a profit.

So if you only have a ten pip range and your spread is two pips, you’re giving up two pips on both sides. You’re probably . . . it’s probably not worth trading.

So typically, you’re going to look for these patterns on a 15 minute chart or higher. You can use a one minute charge if you’re using an ECN account or something like that, where your spread is very small. But if you have a bit bigger spread, 1 pip or higher, you’re probably going to want to watch the 15 minute chart or above.

So we still are going to trade in the direction of the trend, but these are going to be likely short-term trends. For an uptrend, we want to highlight areas of support. For downtrends, we want to highlight areas of resistance. These are strong areas.

Strong areas are where the price aggressively turned and changed at least the short-term trend.

As indicated, we may, based on the other strategies, be buying at a strong support level or selling at a strong resistance level. And if that level breaks, we’re going to get stopped out. That’s fine. But we want to watch for false breakouts, because another trade may develop.

These trades may occur within ranges, and this is really the only ranging strategy that I use. That’s one that we’re going to focus on the examples today, simply because we covered some trending examples the other day. So these ranging examples should give you an idea of what to do if a false breakout develops during a trend.

Ranges aren’t really that common, at least not ones big enough to warrant trading. You will see them on one minute charts, five minute charts, especially overnight when a lot of markets are closed. But big ones that are worth trading, like on an hourly, four hour, daily chart, you’re not going to see them too often, and when you do, it’s normally not going to be in a USD pair.

The USD, as the world’s reserve currency, very trending. So you’re not going to see ranges that last for too long in pairs like the British pound/USD or Euro/USD. It’s not that they don’t happen; it’s just that most of the time, it’s not going to occur.

So we’re going to look for pairs outside of the USD. And in the example I’m looking at today, we’re going to look at the AUD/CAD, which is the Australian dollar/Canadian dollar. And since it is . . . Australia and Canada have similar economies, you have a tendency to see ranges more in those pairs. Similar to the Euro/British pound, you’ll also see more of these ranges develop.

So a range. Once a range is established, we watch for a breakout outside of the prior low or high. At least seven pips. If the breakout quickly fails and then enters back into the range, we take the trade.

So if the price drops below a former range low, then rallies back into the range by at least four pips, we want to buy with a stop just below the recent low. If a price rallies above the former range high, then falls back into the range by at least four pips, we want to sell with a stop just above the recent high.

These pip moves are just guidelines. They may vary a bit by currency. For a very sedate pair, you can maybe knock off a pip or two. For a very volatile pair, you may want to add a couple pips or two.

Basically, all we want to see is that the price did break out, and we want to see a move of at least 7 to 10 pips or so outside of the range. It doesn’t really matter how far it goes, up to about 30 pips. So between 7 and 30 pips. If it goes much further than that, that’s a bit too strong of a breakout to be a false breakout.

So we’re just going to kind of focus on the 7 to about 30 pip breakout. And then if it fails and comes back into the old range by at least a few pips, that’s when we’re looking to take the trade.

So our targets. Once again, we can use 1.6, 2.6, 3.6, but we want to be all out by the time the price has moved 75% of the range. So assume that we have a range of 100 pips. You went short near the top. You want to be out by the time the price has moved 75% of the way to the bottom, or has dropped 75 pips.

If you bought at the bottom, and it’s 100 pips high, you want to be out by the time the price has rallied 75 pips. That’s because in a range, both areas are strong. Normally we’re in a trend and then we move into a range.

So the range caused a change in direction. So both support and resistance are strong. And we do not hold trades into strong areas.

So this can be applied to strong areas during trends. You may have placed an order trusting a strong support or resistance area. As we covered in the last video, that is a trading strategy. But we could get stopped out if the price just moves past our stop a bit.

That’s fine. If the area is strong and the price just barely stops us out, then goes back in the trending direction, we can get back into that trade with a stop just above the false breakout high or low, and we’re going to use these same targets, 1.6, 2.6, 3.6.

I’m not going to cover this one in detail, simply because we covered it in the video prior. But . . . and this ranging strategy should give you enough of an idea of how to trade the false breakouts so you can apply it to that.

So this is the AUD/CAD. It’s a four hour chart. And as you can see, there’s still quite a bit of trending moves, but it does have a tendency to take a few more of these pauses that give us opportunities to trade these sorts of moves.

So we had a high here. The price pulls back. Makes another high here.

At this point, as the second high, we don’t really know for sure this is a range until it actually pulls back. So typically we’re going to need to see probably the third or fourth wave is where we actually get to enter. So at this point, we don’t know if this is a range. We’re assuming this is a trend. So we probably would have been going along down here somewhere based on some of the other strategies.

So this is still a trend at this point. This pulls back. So at this point forward, from here forward, is where we’d be looking more as, okay, we’re starting to establish a range.

So even though this broke slightly above, that is not a false breakout, remember, because we are expecting the price to break higher in a trend. So it did, so that’s not cause for concern. We do not want to short that, because the trend is still up at this point.

After this line, we’ve had a high, a low, a high, a low, in a similar area. So now we’re entering what could potentially be a range. So on this high here, if it popped above by about ten pips or so, and then collapsed back, we’d be looking to short around this former high, or around this red line. That doesn’t happen — it stays below — so there’s no false breakout.

The price collapses. This is a legitimate breakout, because the price does not reenter back into the old range. As you can see, it does by about two or three pips. And as we said, we want to see that move in at least four or five pips. So that’s sort of our filter to avoid just, you know, going long right here, when this was actually a legitimate breakout.

So let’s move over again. So we have this move down here to a high. A new low. So this downtrend would still be in effect. But then we do have some consolidation here. This high does not reach the former, and this low does not reach, but we do have some evidence to suggest that the price is now in a narrowing range. We can see this as different price action from what we’ve been seeing. We’re no longer seeing the overall downward momentum. We’ve definitely slowed.

So we’re entering a potential range here. So we can look for false breakouts here.

This one, very marginal. Yes, it does break the former high, but we are looking at about 4.5 pips above. And if you would have taken it, it would have worked out, if you had been very quick as it popped up, and then dropped back below, and you entered around this line here. Stop just above here.

And then on these, we’re going to . . . especially on a four hour chart, we’re going to use about a five pip stop above the recent high. And you would have got on a few of your targets here as we went down.

So I mentioned, as I said, this is a very marginal example, but I’m going to go through it just so that you get a few more examples. Because I mentioned the height of this range, at least based on what’s been established so far, is a 90 . . . let’s round off to 95 pips. So 95 pips times 75% is 71.2 pips, or rounded to 71.

So what that means is that you need to be out . . . if you did take this short, you would have to be out by the time the price had dropped 71 pips from the old points. That would have been down here. As we can see, the price did not make it to that point.

So you would have probably gotten out two of your targets, possibly just one, at the 1.6, 2.6, and 3.6. So they would have been staggered throughout here. We’d be looking at . . . that’s pretty close there. So let’s say you got in right about there. So 13.6 pips of risk.

So your first target would have been at 21.76. So right about there, 21.8 pips. Fifteen times . . . so the next one would have been at 35, right about there, and 13.6 times 3.6 . . . 48.9. So in this case, you would have gotten out at all three, which would have worked out well.

So if you had taken three micro-lots, or three mini-lots, you would have been able to get out even though it didn’t reach the 75%. So that one would have worked out okay.

But we do want to be out of all of them . . . if the risk had been a bit higher or something, we want to be out of all of them before 71 pips in this case, because the range is about 70 . . . or 92 pips high.

Here we have another one, where it just barely clears this one. You know, we’re talking about a very marginal . . . about a five pip breakout. Like I said, not one I would really concern myself with. Yes, it’s tradeable here, in this case. You would have made a bit of money. As the price collapsed, you would have got out each of your targets down here, very similar to this trade here. So you would have been out by about this point.

No false breakout on the bottom. No false breakout here. No false breakout here.

Slight false breakout here. Again, this is kind of the reason why I like to see a bit more than five or six pips. Normally I’m looking for about seven to ten or more, simply because you can get a lot of this. In this case, you had two trades that worked out, but it’s very common to see this type of thing where it just pops out, pulls back, and then goes.

Now, we have quite a well-established range now, going on. Once again, more of an area now than an exact line. So we can see that this area, it captures this high, captures this high, captures this high, captures this high.

So we have a false breakout here of . . . this one’s quite large, 45 pips. But we have a very strong move back into the range. So once this drop back in, took out that area that we’ve been looking at, I would be looking to go short right in about here.

The likelihood that this is going to continue down is quite high, especially after this long of a time. That was a very good attempt at a breakout, so when it fails, we expect the price to continue lower.

So once again, we would be looking to go short. On this type of trade, I don’t know if it’s going to help in this case. I would drop to an hourly chart, just to see if we can reduce the risk a bit. So in this case, a stop would have to go above here, instead of here. So on the four hour chart, it would have had to go there. But if we drop down, we see that there was a major swing high here, so we can put it there.

But our risk is still going to be quite a bit more than it was on the other trades. About 45 pips. Forty-five times 1.6 is 72 pips, which is right about at the exact point that we said we have to be out of all our positions by. So if we got in right around there, here is our target down here. As you can see, that’s about 75% of the range. Pretty close. And we would have eventually got out as the price continued lower.

So in that case, we would have only taken our 1.6 target, because if we took the 2.6 target, it would be down here, and we do not trade into strong areas. This is a strong area. It has changed the direction of the market. It changed it from a downtrend into a range. So it had enough power to do that. Therefore we’re not going to assume that it’s just going to break.

Big breakout to the downside. Pulls back, but does not enter the old range. So this is not a false breakout.

Looking to the future here, we had a nice strong move up, a move down. We can see the price is starting to stall out. We have a move back to this high.

So moving forward, if the price stalls here again, this is definitely looking to be another potential range, and we can look for these types of setups again.

So a false breakout to the downside here would provide a potential trade, just because we have enough evidence to suggest that there’s a potential range to offer.

So, again, a little bit different concept. These can take a lot of guts to trade, simply because, as traders, for some reason we seem to be wired to want to trade these breakouts. Like something like this, we want to take that short there. You want to buy this. So when it fails, most traders just get very inside their head. They’re very upset the breakout didn’t work.

And you have to really flip your psychology to be able to say, “Wow, that was a very good attempt at a breakout. If it didn’t work, the chances of this collapsing are quite high.” And in this case, it did, and we would have made our target out here. And yes, it did continue to go, but it could have very easily stalled here again and continued with the range.

So we respect the range. We respect the fact that these areas have caused a change in direction. But we will trade the false breakouts up to about 75% of the range.

So in this case, we’re going to trade it down to about here. As we said, this range was about 92 pips. So down to about that area is fine. Once it starts to approach this area, we want to be out of all our positions.

Same as if we had broken below here, we want to be out of all of our positions by about this. In this case, we’re pretty close to 100 pips. We want to be all out by about the 75 pip mark, simply because we’ll be approaching this strong area, and we don’t want to be holding a long position into it.

So every trade has a stop and target. You’re going to need to do a bit of calculation to decide how big that range is, and so you can determine whether you’re going to have a staggered exit, or if you’re just going to have to get all out at once.

In the couple examples we showed, you could use the 1.6, 2.6, and 3.6, and still get out before the 75% mark of the range. In the latter example, we had a much bigger false breakout, the stop was bigger, so we had to get everything out at the 1.6.

Risk 1% or less of your account on a trade. That way even a string of losses won’t significantly draw down your account.

These do take guts and require some reflexes and actually being there to watch for the entry so you can set the appropriate stops, targets, and make the right calculations. Most traders seem to habitually like trading breakouts, which is why this works. But it’s also why it is very hard to pull the trigger.

Stops go five pips above strong resistance when shorting and five pips below strong support when buying, or the last false breakout high or low. If trading on a very short time frame, you can reduce this by a couple pips. But also remember, if you’re trading on a very short time frame, ranges can be very hard to trade. If they’re small, the spread can eat you up. So you’re going to want to probably trade these on 15 minute charts or higher, unless you have an ECN account where you’re basically using a zero spread.

Targets: use 1.6, 2.6, 3.6. If it is a range, you should be out of all positions by the time the price reaches 75%. So that means you may have to knock off one of these, and just get all out at 1.6 or 2.6, et cetera.

Trading involves substantial risk of loss. Only trade with capital you can afford to lose.

Test out strategies before using to make sure you are actually able to implement them. You’ll have to go through and be able to isolate ranges, which can be difficult. You’re also going to have to establish for what pairs, how much does the breakout have to be, how much does it have to move back into the range.

Because each pair is going to be different. I trade about 20 different pairs, so I have an idea what the volatility is in each and what sort of breakout I have to watch for in order to make these sort of trades.

Until next time, happy trading.


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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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