Confirming breakouts is a key task to all forex breakout traders.
As you trade, your goal should be to stack the odds in your favor.
It’s not to be right 100% of the time.
This is not possible neither is it practical.
You can be trading with a good risk to reward ratio and win less than half of your trades and still make huge profits.
You should learn how to spot opportunities in the market, then execute your trading plan accordingly.
Some of the high probability trading opportunities are provided when trading breakouts in forex.
The breakout trading strategy is a popular trading technique in forex.
In this article, I will help you know how to confirm breakouts and learn how to trade them in forex.
Let’s start…
What is Confirming Breakouts?
Most breakout traders only know how to spot the price of a forex pair breaking out through a certain level and trading in the direction of the breakout.
However, that is not enough.
You can enter a trade after the initial candle closes beyond the breakout point, but there are better entry techniques available for you.
More patience is required from the part of the trader, and they don’t materialize always.
However, the goal of each trader should be to trade high probability breakout trades, and not just any setup that is formed.
This will increase your chances of becoming a successful breakout trader.
Most breakouts tend to fail.
With time, breakouts have been failing at a high rate as markets modernize and become more efficient.
However, this doesn’t mean that breakouts don’t work.
Breakout trading is very applicable in the modern forex market and there are many successful breakout traders.
The only problem that traders experience is identifying high probability breakout setups from the rest of others.
Confirming breakouts before jumping into a trade is the key to becoming a successful breakout trader.
It will ensure that you only trade a breakout that exists.
What are Forex Breakouts?
A breakout is said to have occurred when the price of a forex pair overpowers and manages to break out of a particular psychological level.
When you observe the price behavior of a forex pair, you will notice that the price has the habit of moving and conforming to specific levels.
Whenever the price hits a particular level and quickly makes a reversal, this should be considered as a clue about the strength of that level.
And when the price comes back to retest the level, you have to watch the price action closely and expect a potential breakout or rejection trade setup.
In some cases, the price may hit a particular level for a number of times.
This is an indication that the level is stronger than usual.
However, the price will finally break out through any contained levels at some point.
This is the time we say that there is a breakout trade setup.
The occurrence of a breakout in the market is a signal that there is a shift in supply and demand.
As the bulls or bears become more aggressive, an imbalance may occur in the market and cause a breakout to occur through the channel.
It will be important for you to watch for the volume.
It can help you get clues on whether the breakout is real or fake.
Why Trade Breakouts?
Forex breakout trading setups provide traders with nice trading opportunities.
This is because breakouts normally lead to new price moves and trends.
Due to this, traders tend to jump into the market immediately after the occurrence of a breakout so as to get in early on a potential emerging trend.
Additionally, most reliable breakouts tend to occur on high momentum, and price action traders will normally try to maximize their profit from the rapid price moves.
Breakout trading is a simple and a common technique used by traders for a good reason.
Where Do Breakouts Occur?
Knowing where breakouts occur is important for confirming breakouts.
Breakouts normally occur on psychological price levels.
Examples of such levels include:
- Supports or Resistance
- Trend Lines
- Time Highs or Lows
- Price Channels
- Chart Pattern Levels
- Moving Averages
- Fibonacci Levels
- Round Numbers
- Pivot Points
One of the reasons as to why breakouts move the price quickly is that the areas around the potential breakout are watched by many market participants and when one side is capable of pushing through, the other side will have to cover their losing positions quickly, which will cause sharp price movements after the occurrence of the breakout.
Identifying Breakouts
There are different types of breakouts, including trend line breakouts, horizontal price breakouts, Moving Average breakouts, Fib level breakouts, and others.
It is your job as a trader to identify high probability breakout opportunities and execute the trade.
However, when trading forex, confirming breakouts is not an easy task.
The support and resistance lines that are drawn at potential breakout points should be seen as zones instead of fixed lines.
This strategy requires the user of trader discretion to minimize fakeouts and false signals.
For example, suppose the price of a forex pair is trending upwards.
However, the bottoms of the price action cannot be connected using a single straight line.
This does not mean that there is no trend.
It only means that you should not consider the trend as being contained by a single thin line.
Instead, you should see the trend as a zone.
The price may also pierce through and interrupt the upward sloping trend line.
This does not mean that the trend is over.
You must be keen of a possible reversal, but know that the price can pierce the trend line at times, without the price reversing.
The price will make fluctuations and it’s possible for the price to make small breaches through the levels.
This rule also applies to other levels other than trend lines.
That’s the importance of seen these levels as areas rather than fixed lines.
So, each trader must master the process of confirming breakouts and distinguishing them from fakeouts.
Determining the Psychological Areas
When you realize that the price of a forex pair is conforming to a particular level over and over again, you should consider that as being a psychological area.
You can take the lowest and the highest level of the price around that level then treat the distance between the two lines as a support/resistance area.
However, if there is a candle on this level whose wick goes beyond the logical scope of the level, it should be disregarded as part of the psychological area.
Consider the following chart…
The above chart shows an example of a breakout that occurs through the support line.
The support line is the black line running horizontally across the chart.
The price stayed in a sideways movement for some time.
This led to the creation of a consolidation period within the market.
During this time, a number of bottoms were created, and this led to the formation of our support area.
When trading breakouts, it’s good for the trader to wait for a candle close beyond the support/resistance area as a way of confirming breakout.
In the above chart, when the price closes a candle below the support area, that is identified as a bearish breakout.
This has happened at the red candle pointed to by a red arrow marked as Breakout.
After that, the price entered into a very strong downtrend.
The downtrend continued for some time.
Consider the following chart…
The above chart shows the price of the forex pair forming a range.
The price appears to be making a sideways movement in between two horizontal lines.
The upper horizontal line can be seen as a resistance line, while the lower horizontal line can be seen as a support line.
The price keeps on hitting and bouncing off these two horizontal lines for some time.
When the price is trading within a range, no trader can predict the direction of the breakout.
This means that when the breakout occurs, it can send the price of the forex pair in either direction.
So, as a trader, you should watch both the support and resistance lines for clues.
Once you have identified the likely breakout direction, you should react by entering a trade in that direction.
On the lower side of the range, a number of bearish candles managed to go deep into the support line.
Most traders will jump into short positions and others will exit their long positions after seeing this.
However, the bearish trend did not continue for long, but it instead made a reversal into a bullish trend.
That’s why instead of using a single line as support, it is better to have an area that you count as the support zone.
This can help you greatly when confirming breakouts.
The eventual breakout occurred to the upside.
This position has been pointed to by a black arrow marked as Breakout.
The bullish breakout is very strong as shown by the strong bullish candles formed at the time of the breakout.
After the breakout, the price did not come to retest the former resistance line as a support line.
Instead, the price continued to make a bullish move.
In some cases, the price will make a small bearish move and hit the former resistance line as a support line, and then bounce off it to resume its bullish move.
The former resistance line will have changed into a strong support line.
This acts as a confirmation for the current bullish breakout.
This type of breakout pullback is a very important confirmation signal in breakout trading.
Distinguishing Real Breakouts from Fake Breakouts
A candle wick that is beyond a psychological area is not a breakout.
I only consider a breakout to have occurred when the price of a forex pair closes the candle beyond the level.
This gives a more reliable breakout signal, which can in turn be used by a trader to enter a trade in the breakout direction.
Consider the following chart…
The chart shows the occurrence of a bullish breakout and fake breakouts on the price chart of a forex pair.
The price is moving in a range, which has been marked by the two black horizontal lines.
The upper line is the resistance line, while the lower line is the support line.
The resistance line contains all the tops of the price, except two candles which are pin bar style rejection candles.
These two candles form false breakouts to the upside.
The two have been pointed to by two black arrows marked as Fake Breakouts.
The two candlesticks managed to go above the resistance area.
However, the candlesticks didn’t close with their full bodies above the resistance area.
Due to that, these two breakout signals can be disregarded and termed as fake breakouts.
There are also false breakouts to the downwards.
These have been shown by the three red candles whose wicks managed to go past the support line downwards.
However, these three candles strongly bounced off the support zone.
Since there is no candle that closes below the support area, these three can be term as fake breakouts.
These three candles were followed by the formation of very strong bullish candles that pushed the price of the forex pair upwards to the point of hitting the resistance line.
The real breakout occurred after the formation of the second fake bullish breakout.
This is the first time that we get a candle closing above the resistance level.
This position has been marked as Real Breakout on the chart.
The breakout candle is a very strong bullish candle, which acts as a confirmation that it is a reliable breakout signal.
This breakout has been followed by a very strong bullish trend in the market.
4 Steps for Confirming Breakouts
It is not enough for you to wait for the price of a forex pair to breakout through a level then you enter a trade in the direction of that breakout.
It’s possible for you to enter a trade once a candle manages to close beyond an established level, but there are better techniques that you can use to confirm breakouts and enter into trades at the right time.
Here are 4 steps that you can use to confirm breakouts.
We will also set some rules that you should follow to trigger a breakout trading position.
Step 1: A candle closes beyond an established level
Consider the following chart…
The chart shows the price of the forex pair increasing gradually and finally hitting a resistance line.
The resistance line is the black line running horizontally across the chart.
When the price encountered this line, it begun to make a sideways movement.
The price made a number of attempts to break through the resistance line upwards, which has been shown by the tops created during the sideways movement.
The price finally managed to close a candle above the resistance line.
This is the position that has been marked as Breakout on the chart.
This was followed by a very strong bullish move in the market.
So, a candle that closes beyond an established resistance or support area may signal a breakout.
Step 2: Price forms a top after the breakout
Consider the chart given below…
In the above chart, the price made a breakout through the resistance line upwards.
It then formed two tops.
These have been shown by the black line running horizontally and marked as Forming Tops.
For the case of the tops, it will be good if they are fractal formations.
This should also be the case when dealing with bottoms.
Step 3: The price pulls back to the broken resistance
During the formation of the tops, the price moves upwards, then begins to move downwards until it touches the previous resistance line, which is now acting like a support line.
What the price is doing during this time is that it is retesting the former resistance line.
However, each time the price hits the former resistance line as a support line, it bounces off it and begins to move upwards.
This is a signal that the resistance line has turned out into a very strong support line.
This means that there are no chances for the price to move downwards because the strong support will strongly resist the bearish move.
Step 4: The top after the breakout is broken
After testing of the previous resistance line now turned support, the price made a very strong bullish move.
It then managed to break through the horizontal line running through the tops that have been created.
This acts as a strong confirmation that there are high chances of the price continuing to move in the bullish direction.
Of course, we need to see a candle close above the top that was created after the breakout.
The above 4 step breakout signal confirmation can be used to trade range consolidations.
Range consolidations are situations in which there is a breakout in a chart pattern and you expect to see the price moving equally to the size of the formation.
How to find a Good Breakout Indicator
The process of confirming breakouts can be a challenge, especially to traders who are not good in reading price action.
In such a case, the trader is advised to choose a technical indicator that can help him to confirm breakouts.
An example of such a technical indicator is the Momentum indicator.
This indicator is made up of an area and a curved line which fluctuates in the area of the indicator.
If the Momentum is moving upwards, it acts as a signal that the price is most likely to follow that trend.
On the other hand, if the Momentum is moving downwards, it acts as a signal that the price will decrease too.
Also, if the Momentum gives extremely high readings, it’s an indication that the uptrend may continue.
If the Momentum indicator is showing extremely low readings, it’s a signal that the current bearish trend is most likely to expand.
The most optimal way of using the Momentum indicator is in spotting divergences.
A bullish divergence is said to have occurred when the price is moving downwards at a time when the Momentum Indicator is increasing.
A bearish divergence is said to have occurred when the price is increasing at a time when the Momentum Indicator is decreasing.
The divergence acts as an indication that the price may make a reversal sooner.
Consider the chart given below…
The above chart shows how a Momentum indicator works with the breakout trading strategy.
The momentum indicator has been added on a separate window at the bottom of the price chart.
The price is initially in a bullish trend.
Suddenly, the Momentum indicator begins to form lower tops as the price continues to increase.
This means that there is a bearish divergence between the price and the Momentum indicator.
It also acts as a signal that there is a potential bearish move in the market.
The price managed to close with a candle below the support line.
This is the bearish candle whose body cuts across the support line.
This was followed by a very strong bearish move in the market as shown by the red arrow running downwards on the chart.
So, the moment the trader saw the bearish divergence in the market, that is, the Momentum indicator moving contrary to the price, the trader should have prepared for a bearish move by exiting a long position and possibly entering a short position.
Conclusion:
The breakout strategy is an effective way for a trader to enter the market in the early stages of a trend.
A breakout is said to have occurred when the price breaks and closes beyond a psychological level on the price chart.
Confirming breakouts before entering the market is key to becoming a successful breakout trader.