False Breakout - How to Avoid
and Even Trade It?
3
Have you ever seen a key resistance level breached and entered a
long position right before the market turns the other way and dumps
hard?
Have you watched price smash through support, entered into a short
position only to watch the market bounce?
Don’t feel bad, this has happened to everyone – you’re just one of
many victims of the false breakout and learning to spot these things
can be tricky.
Read on as we discuss breakouts, fakeouts and introduce two
powerful indicators from the FXSSI team that can help you stay on the
right side of the market and avoid further pain.
Breakout vs Fakeout
So what is a breakout?
What about a false breakout or fakeout?
More importantly, how do we tell the two apart when trading?
Breakouts
A breakout is when the price of an asset breaches a support or
resistance level that has previously contained price.
In the case of bullish breakout, the broken resistance level should now
act as support and in the case of a bearish breakout, the opposite is
true – support should now become resistance.
Once this support or resistance level has been breached and
respected, you will often get substantial price continuation in the
direction of the breakout.
This isn’t always the case though, sometimes the market has
something nasty up its sleeve.
False breakouts – the fakeout
As the name suggests, a false breakout or fakeout is when you get no
continuation following a breakout.
It’s often a lot worse than that though, many times the asset you are
trading will reverse direction entirely and move decisively against you.
Combined with poor money and risk management practices, fakeouts
can be truly devastating to your psyche and account balance.
Identifying fakeouts before they
happen
It’s all well and good to identify true breakouts and fakeouts after they
happen, after all, hindsight is 20/20 and this is even more applicable
when it comes to trading and charting.
Identifying whether a breakout has potential or not as it’s actually
happening is the real challenge.
Luckily for you, FXSSI members have access to a great indicator that
can help you do just that – the Profit Ratio indicator.
Most traders lose
FXSSI’s Profit Ratio indicator was formulated around the fact that the
overwhelming majority of traders lose money.
Combining this knowledge with broker order book data, we’ve
developed an indicator that offers powerful insights and trading signals
that can often lead to significant market reversals.
The Profit Ratio indicator simply tells you what percentage of traders
on our sampled order book are currently in profit.
As we know most traders lose money, if we see an awful lot of traders
in profit, chances are their luck is about to run out and a reversal could
be imminent.
As the Profit Ratio indicator is a reversal indicator, it is perfect for
assessing whether a breakout is indeed real and worthy of a trade, or
just a fakeout primed for you to fade.
Avoiding and trading fakeouts
Avoiding and trading fakeouts with the Profit Ratio is very simple, as
the indicator highlights potential reversal points on the signal line with
an orange dot.
If you see price break through a significant support or resistance level
and the indicator is showing an orange dot, it would be wise to stay
clear of the breakout.
If the following candle takes price back inside it’s previous range,
there is a strong chance you are looking at a fakeout and you can
open a position accordingly, trading the potential reversal.
In the example above, the Australian Dollar spikes above the 73 cent
mark against the US Dollar as the Profit Ratio indicator is signalling a
potential reversal – we do not trade this breakout.
As the following candle respects the previous range, we enter a short
position, price then declines more than 1% and we exit on the
opposite signal.
Note the blue moving average line on the indicator, reversal signals
that occur above this line are more significant, this is why we ignore
the first one.
If you want to play it safe, you could use a trailing stop to protect your
position if you see one of these weaker signals – this keeps you in the
market until a reversal signal occurs above the average, whilst also
protecting your profits if the first signal was legitimate.
Stop hunting
Have you ever set your stop loss position right above or below an
obvious swing?
What happened?
In a really strong trend you may get away with this, but a lot of the
time stops like this will be triggered, only for the market to reverse
back in the direction you were trading.
This is known as stop hunting and there is nothing more frustrating.
What’s happening here is that larger institutional players require
liquidity to enter their large positions, that is if they are looking to buy,
they need to buy where there’s lots of people selling.
There’s actually nothing nefarious going on here – stop hunting might
be a more accurate term – the big players are simply betting they can
get filled where you’re trying to cover your losses.
FXSSI’s Stop Loss Cluster indicator is an incredibly useful tool which
shows you where other traders are placing their stops – now you can
trade like the big guys do!
Fakeouts always trigger stops
If a bullish breakout is driven by stop’s being triggered and not new
willing buyers, there’s a good chance that breakout is going to fail.
The same goes for a bearish breakout – if no new sellers are trading
the breakout, what will drive price lower?
This is why breakout traders wait to see if price respects the former
support or resistance level before trading.
Fakeouts are nearly always accompanied by stop hunting.
As you can see from the chart above, the stop loss clusters are
triggered time and time again, only for price to reverse – that’s a lot of
traders leaving money on the table.
As a healthy breakout is usually accompanied by stops being
triggered as well, the Stop Loss Cluster indicator is best combined
with another indicator like our Profit Ratio indicator.
Trade fakeouts like a pro
Combining FXSSI’s Stop Loss Cluster indicator with our Profit Ratio
Indicator can yield some very impressive results.
Both indicators will help to filter low quality signals from the other,
helping you avoid bad trades and only take the best opportunities.
In the example above, the New Zealand Dollar breaches the previous
high against the US Dollar as the Profit Ratio indicator issues a
reversal signal.
Though this trade would have been successful if your stop was wide
enough, by waiting for a signal confirmed by a stop hunt, you get a
much better entry, shorting the actual top right before a substantial
decline.
Recap
A breakout is when price breaches support/resistance, respects
and continues.
When trading breakouts, wait for price to respect the broken
level.
A fakeout occurs when support/resistance is breached without
any continuation.
Fakeouts often lead to substantial reversals.
Most traders lose money, FXSSI’s Profit Ratio indicator tracks
net trader profitability.
The Profit Ratio Indicator can help you identify fakeouts as they
are happening.
Big money traders need to buy when other people are selling to
get filled.
Our Stop Loss Cluster indicator highlights where this activity is
likely to take place.
Combine the Stop Loss Cluster & Profit Ratio Indicators and
trade fakeouts like a pro.
