Forex breakout strategies are commonly used by many traders as a relatively simple and reliable way of securing profits with consistency and confidence. As with all styles and strategies, trading forex breakouts do come with their own distinct pot holes and challenges – in this article we’ll look over the concept of breakout trading and how traders can use this specific forex tactic within their own trading plans.
What You Need To Know About Forex Breakout Trading
1. What Is A Breakout & How To Identify One? A forex breakout occurs when a currency pair pushes above or below a previously settled trading range. For example, if the GBP USD pair has previously been unable to punch past 1.5500 over a period of months, a breakout would occur when the pair finally manages to scale this height. Price breakouts can be exciting events, since the currency pair will often push on to explore dynamic new price points which may be profited from.
2. Breakout Or Fakeout? The challenge for the forex trader is to determine that the pair has indeed made a genuine breakout. Sometimes, a currency pair may feign to breakout by scaling new highs or lows outside of its previous range, only to settle back down again into that same range. This is known as a fakeout. Opening a position on a fakeout can be highly dangerous and lead to severe losses should strict discipline not be practiced.
3. Constructing Your Breakout Trading System. A good system can help you to pick out forex breakouts so that you can position yourself early within the breakout. Here are some important considerations when setting up your breakout trading strategy:
- Learn to construct technically accurate trendlines and support/resistance levels. To be able to trade breakouts with any punch, the trader must be able to understand where genuine resistance and support areas are. They must also learn the art of constructing trendlines, since these can determine bullish and bearish channels.
- Demonstrating Patience Before Determining & Entering A Breakout Position. An interesting nuance of breakout trading is that the price action often returns to test the breakout level. For example, if the breakout is bullish and breaks resistance at 1.5500 as in our earlier example, the price will often retest the 1.5500 level even after the breakout. The 1.5500 level flips from becoming resistance into support.
- Employing Strict Stop Losses When Using Breakout Trading. Stop losses are always crucial. However, when pursuing forex breakout strategies, they are critically emplyed in the event of a fakeout, when the price may retreat aggressively against the traders breakout position. Using a snug stoploss will ensure the trader can leverage lavishly upon genuine breakouts while keeping losses from fakeouts to a bare minimum.
4. Accounting For Sentiment At The Point Of Breakout. There are some clues the astute forex trader can pickup to determine a genuine breakout from a fakeout. One of these is in understanding the general sentiment at the breakout point. If a currency pair sees a downside breakout of a previously strong support area – and the newsflow and sentiment surrounding the pair is feverishly negative…there is simply more likelihood that the downside breakout will prove to be genuine.