Trading support and resistance breakouts is a method that attracts the attention of many forex traders.
It’s a great way of earning quick profits if you grasp it right.
However, it is not easy to trade breakouts as you might think.
When look at a chart after a breakout, breakout trades look easy.
However, as you watch the market for potential breakouts, you will realize that things are not easy.
If you ask any breakout trader, they will tell you that their experience is filled with whipsaws and false moves.
This means that a lot is needed for one to become a successful breakout trader.
Breakouts normally occur through established levels like support and resistance.
This means that you must know how to identify the positions of these levels on your price chart.
However, in most cases, the position of these levels is subjective, meaning that different traders will choose different levels for support and resistance lines.
Due to the high number of false breakouts, you must know how to implement proper risk management strategies.
In this article, I will help you know how to trade support and resistance breakout.
What is Support and Resistance Breakout?
Support and resistance are core tools in price action trading.
When using the support and resistance breakout trading strategy, one of the most essential skills is to be able to tell whether a breakout through the support or resistance level will hold or fail.
Consider the following chart…
The above chart shows the occurrence of a breakout through both the support and resistance lines.
The first black horizontal line on the chart is a resistance line.
The price attempts to breakout through this line upwards but it fails constantly.
Finally, a bullish candle managed to close above the resistance line, which is a signal that a bullish breakout has occurred in the market.
This position has been pointed to by a black arrow marked as Breakout through Resistance.
This was followed by a strong move upwards.
The second black horizontal line on the chart shows a support line.
The price makes attempts to breakout through it downwards but it fails constantly.
Finally, a bearish candle managed to close below the support line.
This confirmed the occurrence of a bearish breakout in the market.
This position has been pointed to by a black arrow marked as Breakout through Support.
This was followed by a strong move downwards in the market.
Traders who use the support and resistance breakout trading strategy make money once the support and resistance lines fail.
When the resistance line fails, your goal is to buy as the market breaks out above it.
In the above chart, traders should have taken long positions by buying the forex pair at the position marked as Breakout through Resistance.
The resistance line failed to prevent the price from increasing, thus creating an opportunity for traders to jump into the market and take long positions.
When the support line fails, the goal of buyers should be to sell as the market breaks out below it.
In the above chart, traders should have entered short positions by selling the forex pair at the position marked as Breakout through Support.
This is the time when the support line failed to prevent the price of the forex pair from decreasing, thus creating an opportunity for traders to jump into the market and take short positions.
The following chart demonstrates this correctly…
The above chart shows the time when traders should buy the forex pair as well as the time when traders should sell the forex pair.
Buying should happen at the position where the resistance line fails, while selling should happen at the position where the support line fails.
So, here are the two essential steps to the breakout trading strategy…
- Find a market that is trapped between support and resistance lines. During such times, the price action normally forms trading range type patterns such as a triangle or a channel.
- Wait for the market or the price to breakout through the support or resistance level. For a support line, the market should breakout downwards while for a resistance line, the market should breakout upwards.
- Enter the market as volatility increases after the breakout.
So, breakout trading relies on the basic support and resistance as its premise.
This means that this trading approach can be applied on any time frame, including daily and intraday time frames.
See breakout trading as a type of momentum trading.
This means that traders:
- Wait for momentum to enter the market.
- React to but don’t predict the market movement.
- Buy high and sell low. Some traders may not be comfortable with this.
- Profit from an increase in volatility.
Next, I will be giving you tips that you should put into practice when trading using this strategy…
Tips for Support and Resistance Breakout Trading
When using breakout trading, always put the following tips into practice…
#1: Wait for higher volume to confirm a breakout
Volume is a great way for confirming breakouts.
An increase in volume acts as a confirmation for the breakout.
Of course, you will want to see a period of low volume trading before an increase in volume.
So, always add the volume indicator to your forex charts.
Consider the chart given below…
The above chart shows the behavior of the price of a forex pair in relation to the volume indicator.
The point marked as 1 shows that there was a minor surge in volume but no support or resistance line was broken.
The point marked as 2 shows the price of the forex pair breaking through the resistance line upwards.
A closer look at the volume indicator at the same time shows that the volume is high and increasing.
This is a good time for forex traders to jump into long positions in the market.
A strong bullish move occurred after this breakout.
So, the high and the increasing volume was a signal that the breakout is valid.
Traders who had taken long positions will make profit from the bullish price move.
The point marked as 3 shows the occurrence of a bearish breakout through the support line.
A closer look at the volume indicator at the same time reveals that the volume is high and increasing.
The breakout was followed by a very strong bearish move in the market.
Traders who had taken short positions will make profit from the decrease in the price of the forex pair.
This means that the high and increasing volume during the time of breakout was a confirmation that the bearish breakout is valid.
#2: Trade breakouts in the trend direction
Always follow breakouts that follow the prevailing trend.
A breakout trade can involve any chart formation including a range, a wedge, or a triangle.
However, it will be simpler for you if you focus on breakouts in the direction of the trend.
You only need to get two swing points that you can use to draw a trend line to act as support or resistance line against the trend.
Consider the following chart…
In the above chart, we have a support line drawn between two swing points.
The two swings created bottoms, and these were used to draw the support line.
The price finally managed to break out through this support line downwards.
The breakout was followed by a very strong bearish trend, meaning that it was wise for the traders to trade in the direction of the dominant trend.
This means that they should have entered short positions by selling the forex pair.
#3: Take advantage of volatility cycles
In every market, there will be periods of high volatility as well as periods of low volatility.
If you are an intraday trader, it is easy for you to uncover these cycles.
You simply have to analyze the average hourly range of your market.
In most cases, a couple of hours account for the majority of a session’s range.
Once you become attuned to the volatility cycle, you can use it to:
- Look out for trading ranges during low volatility periods.
- Enter breakout trades during high volatility periods.
However, it is difficult to grasp volatility tendencies on daily charts.
The reason is that they depend on fundamental drivers.
For example, the volatility may increase after the announcement of a new item.
Also, it’s worth noting that spending more time trading doesn’t translate to making more profit.
Instead, what matters is trading during the right time.
#4: Enter the market on retest of Support or Resistance
If your goal is to trade high probability trades, it will be good for you to enter the market upon a retest.
When a support or resistance line fails, its role changes.
If the line was acting like a support line, it will begin to act like a resistance line.
Due to this, the price may come back to retest the former support turned resistance.
If the support has developed to become a strong resistance line, the price will bounce off again and resume its bearish move.
This will act as a confirmation that the bearish breakout was real.
If not, the price will breakout through the line and begin to move upwards, which will be an indication that the bearish breakout was a fakeout.
If the price breaks out through a resistance line, this will change its role into a support line.
The price will then come back to retest the level and check whether it has become a strong support line.
If the price bounces off the line and resumes its bullish trend, it will act as a confirmation that the bullish breakout was real.
It’s a nice opportunity for traders to enter long positions by buying the forex pair.
Consider the chart given below…
The above chart shows the occurrence of a bearish breakout on the price chart of a forex pair.
The breakout occurred at the position pointed to by a black arrow marked as Bearish Breakout.
The price then made a bearish move after the breakout.
However, the bearish move did not continue for long before the price made a reversal and begun to make a bullish move.
The price managed to hit the resistance line which was previously acting like a support line.
The price is now retesting this level to see whether it has changed into a strong resistance.
Upon hitting this level, the price bounced back and begun to make a strong bearish move.
This acts as a confirmation that the level has actually become a strong resistance line.
It also acts as a confirmation for the bearish breakout.
It is now a good time for traders to enter short positions by selling the forex pair.
There are two advantages associated with this approach…
First, the trader will be depending on a confirmed support or resistance level.
This will give the trader a higher probability setup.
Secondly, the trader can expect the strategy to exhibit less adverse movement.
This will give you an opportunity to setup a tighter stop loss for your trade.
A tighter stop loss means minimal or no loss when the market makes a reversal because you will exit the trade early enough to avoid incurring a heavy loss.
However, if you are one of the impatient forex traders, this strategy is not good for you.
You may be forced to wait for a pullback that will never occur.
Of course, the price may come to retest the support or resistance level or it may never do so.
This means that if you choose to use this strategy, you must be ready to lose some highly profitable breakout trades.
#5: Have a predetermined exit plan
After the occurrence of a breakout, the volatility of the market will increase.
This means that it is of great importance for you to have a clear exit plan that you can execute without hesitation.
There are two approaches that you can use to exit the trade
Let’s discuss them…
Setting Profit Target
A support and resistance breakout normally occurs after a consolidation period in the market.
The consolidation period normally leads to the formation of chart patterns like triangle and price channels.
So, the natural target should be based on this formation.
Consider the chart given below…
The above chart shows the formation of a bullish breakout after the formation of a triangle pattern.
The triangle formation has been shown by the two black lines added on the chart.
A breakout through this triangle occurred upwards at the point marked as Entry.
This is the right time for traders to enter a long position.
To set a profit target, the size of the triangle formation has been measured.
This height has then been used to set the position of the profit target from the entry point.
The profit target should be set at the level shown by a green horizontal line marked as Profit Target.
There was a small market consolidation at this point which provided traders with an opportunity to take their profits.
The good thing in this case is that the bullish trend managed to hit the level of the profit target.
However, the market continued to trend upwards even after hitting the profit target.
This means that the trader will miss out on making additional profits because he will exit the trade at a time when it’s too early.
I will be showing you how to overcome this so that you don’t watch the market moving in a favorable direction when you are outside the trade.
A volatile market will often breakout quickly and snap back quickly.
That is why you should set actual limit orders.
If you decide to use the wait and see approach, you may have to give back the meaty part of the move.
Experienced traders can show much flexibility and exit once the market momentum falters.
The only time that you should let your profits to run without you setting a fixed target is when you expect a new trend to be formed.
A good example of this is when the market is breaking out of a significant price pattern that is showing signs of accumulation.
Let’s discuss the second approach that you can choose to exit your trade…
Using a Stop Loss
You have two choices for this…
The ideal place to set a stop loss is at the opposite end of the trading range.
If the price formation covers a huge price range, this approach will carry an excessive risk.
It will be good for you to use a trailing stop loss.
This type of stop loss will shift its position whenever the price moves in a direction that favors you.
After every shift, the stop loss will lock in the profits that you have earned so far.
In case the price makes a reversal, you will not loss the profits that have been locked.
This type of stop loss will give you an opportunity to stay in the trade for long and earn more profits.
In the above chart where we used a profit target to exit the trade, you realized that the market continued to move upwards even after exiting the trade.
A trailing stop loss will prevent you from exiting the trade prematurely.
Other than the trailing stop loss, you can use an ordinary stop loss to exit the trade.
With this type of stop loss, you will stay in the trade provided it has not been triggered.
However, it doesn’t shift its position even when the market moves in a direction that favors you.
The moment the market makes a reversal and begins to move against you, the stop loss will be triggered and you will immediately exit the trade.
This will protect you from making a loss.
When using the support and resistance breakout strategy, do not tighten the stop loss to the breakout point too soon regardless of the type of stop loss that you choose to use.
Remember that after a breakout through either the support or resistance line, the price may come to retest the level.
If you had placed your stop loss too close to the breakout point, it will be triggered unnecessarily and you will end up exiting the trade when it’s too early.
You may then find yourself in a situation where the price is moving in a favorable direction but you are out of trade.
This way, you will miss out on making profits.
#6: Trade false breakouts
As you learn how to trade using support and resistance breakout, you will also gain insights about false breakouts.
Although they are false, they present trading opportunities that you cannot miss to make profits from.
The following recipe will help you win trading false breakouts…
Look for breakouts:
- That are from a minor price formation.
- That are against the trend.
- That fail swiftly.
#7: Scan for breakout candidates to save time
One of the ways through which you can streamline your trading process is by scanning for breakout candidates.
If possible, use your scanner to scan for chart patterns such as wedges, flags, and channels.
You can also scan for forex pairs with decreasing volatility to add to your shortlist.
You can achieve this using the Bollinger Bandwidth or falling ADX values.
However, don’t set an automatic trade entry based on a scan.
Always take time to review the charts individually and do away with the bad candidates.
Support and resistance breakout trading combines the essential price action trading skills into one approach.
If you are a price action trader, you can’t ignore the power of breakouts.
Once a breakout occurs in the market, you need to wait for it to be confirmed before jumping into the market.
The confirmation happens when the price makes a pullback and comes to retest the support or resistance line and then bounces off the level to resume the breakout direction