There are many trading strategies traders use to tackle the forex market, but only a few can be as reliable as the London breakout trading strategy, which institutional traders have been using for a long time to gather some early morning pips. The good thing is that retail traders can learn it and add to their trading arsenals.
The strategy is very beneficial to intraday traders, and it is one of the easiest strategies to implement. It offers a quick way to make some nice pips in a few short hours — the trade may be done in less than three hours. A swing trader can even use it to catch some quick pips.
So, in this post, we will try to explore the London breakout strategy. Here are some of the things you will learn:
- The different market sessions and why the London trading session is unique
- The pre-London trading range
- What the London breakout trading strategy is all about
- The best time to trade the strategy
- Why the strategy works
- The best currency pairs to trade with the strategy
- How to trade the strategy
- Advantages of trading the strategy
- Disadvantages of trading the strategy
London breakout trading strategy: What to know about the London trading session
Unless you are new to forex trading, you should know that there are different trading sessions in the forex market. As you can see in the picture above, there is the Sydney Session, the Tokyo Session, the London Session, and the New York Session. The Sydney and Tokyo sessions are referred to as the Asian session, while the London session corresponds to the European session. However, the European session starts with the Frankfurt market open, which comes an hour before the London Session.
From the picture, you could see that there’s a period of overlap between the Tokyo Session’s closing hours and the opening hours of the London Session. As Asian traders are winding down and London and European traders are taking positions in the market, market volatility tends to increase around this period.
London is one of the biggest financial centers in the world, and it is a major hub for forex trading. In fact, it is the most active financial center in Europe for forex trading. So, the period around the London market open is known to have enough liquidity, as major banks are placing trades for themselves and their corporate clients. The interbank market activity also drives volatility.
Moreover, the period around the market open is associated with the release of some high-impact news, which further increases trading activity and market volatility. All these make the period around London a perfect time to trade a breakout strategy — the London breakout trading strategy.
London breakout trading strategy: Establishing the pre-London trading range
For a trading system to be a breakout strategy, the price must be seen to break above a resistance level or below a support level. In the case of the London breakout trading strategy, the resistance and support levels were set during the pre-London trading hours, which include the Asian session (Sydney, Hong Kong, Tokyo, etc.) and probably the first hour after the Frankfurt Open.
If you are conversant with the forex market, you would know that, during the Asian session, the price often tends to stay within a relatively small range. Unless there is a big political, economic, or social news during the Asian trading session, the price rarely makes any big moves in that session. Thus, the price range formed in that session, before the London market opens, is known as the pre-London trading range or the Asian session range.
There are two ways to define this range: The first one is to mark the highest and lowest price level during the Asian trading session, which is the first session of the new trading day. With this approach, you are considering the entire price action, including the candlestick wicks.
The other approach is to use the closing prices of the uppermost candlesticks in upswings and the lowermost closing price in the downswing during the trading session. In this case, the focus is on the candlestick bodies which is where the real price actions took place during the session. This gives a narrower range, so it allows a faster breakout, which helps you to enter the market earlier.
What is the London breakout trading strategy?
The London breakout trading strategy is a trading approach that seeks to benefit from the breakout of the range market that formed during the pre-London trading sessions. So, it is a breakout trading method where a broker aims to go long if the price breaks above the upper boundary of the pre-London trading range or go short if the price breaks below the lower boundary of the pre-London trading range.
While the strategy may seem that simple, you may need some trading acumen to spot when the smart money is playing their tricks and creating false breakouts, as they search for orders to fill theirs. One good thing about this smart money trick is that they leave their trail, and if you can spot it, you can have a high probability trade.
What this means is that a false breakout might actually be a good thing after all, since it may show that the price is more likely to genuinely break out in the other direction. A false breakout is even more significant if it occurs against the trend already in place before the pre-London trading range, as it further supports a potential breakout in the direction of the trend.
To put it all together, a breakout of the Asian trading range is more likely to work if it occurs in a direction that supports the continuation of the prevailing trend before the emergence of the Asian trading range. Secondly, a false breakout increases the likelihood of the real breakout occurring in the opposite direction, and if this corresponds to the direction of the prevailing trend, you have a confluence of two supporting factors that increases the odds of success.
For example, if the price was in an uptrend before the Asian trading range, it is believed that a breakout above the range is more likely to work than a break below the lower boundary of the range. Now, if during the first one hour of the Frankfurt Open, there was a false breakout to the downside, expect a genuine breakout to the upside when the London session opens as both the direction of the trend and the downward false breakout support a breakout above the trading range.
Another important thing to note about the London breakout trading strategy is that it is best suited for day traders. So, the best timeframes to trade the strategy are intraday timeframes, especially lower than the hourly timeframe. Most traders prefer to use the 15-minute and 5-minute timeframes. Although the strategy is best suited for day traders, it doesn’t mean that swing traders can’t step down to lower timeframes and pick some quick pips.
The best time to trade the London breakout trading strategy
Many active traders have come to realize that the best time to analyze and trade the London breakout trading strategy is the 2-hour period that spans from an hour before the London market open to an hour after the open. Since the London market opens by 8:00 am GMT, the best time for the strategy is from 7:00 am and 9:00 am.
The Frankfurt market and most of mainland western European markets open an hour before the London market opens, so the period is often marked by an increase in price volatility. Interestingly, the price movements that occur during this period, especially the last 30 minutes before the London Open, may give a clue as to the direction the price will go when Londoners come on board.
Most often than not, London traders will turn the price around especially if that movement is against the prevailing trend.
Why the London breakout trading strategy works
There are many reasons why the London breakout trading strategy works very well. One of them is that the Asian traders, especially the Japanese, are winding down — closing their positions or adjusting them in readiness for the European session. At the same time, Frankfurt and London traders are taking positions to start their trading day.
All these orders provide plenty of liquidity to the market, as well as create a lot of volatility, which drives price movements, creating breakout trading opportunities. Moreover, around this period, major British and European minds are starting their day, taking positions for both themselves and their corporate clients.
So, apart from the usual liquidity and volatility associated with this period, there is a lot of interbank activity, which leaves some trading footprints that experienced retail traders can follow and trade the market in the direction of the smart money. All these and more make the London breakout trading strategy an effective way to pick some early morning pips over a short period.
London breakout trading strategy: The best currency pairs to trade
It is important to know the ideal currency pairs to trade with the London breakout trading strategy, since not all currency pairs move the same way during the period of overlap between the Asian and London trading sessions. Some perform significantly better than others, owing to the currencies that make up the pair.
So, you should expect that some of the best currency pairs you can trade with the London breakout trading strategy include GBP and JPY-containing pairs, such as GBP/JPY, GBP/USD, EUR/GBP, and EUR/JPY. However, your choices are not limited to only these ones. Other major currency pairs you can also trade with the strategy are the USD/JPY, EUR/USD, AUD/USD, and other majors.
Although some of the largest movements occur in the GBP/USD, you shouldn’t bother too much about the currency pair you trade, as a lot of other currency pairs also have good volatility during the London market open. Just pick a few currency pairs first and see how well they perform with the strategy.
How to trade the London breakout trading strategy
The London breakout trading strategy is very simple to implement. You just have to determine how you want to implement the strategy. There are two ways to implement the London breakout trading strategy:
- The direct breakout strategy
- Fading the pre-London false breakout
With this method, you enter the market once the price breakout out of the pre-London trading range — that is, the price closes above the upper boundary of the range or below the lower boundary of the range. But not all breakouts are worth trading since there can be many false breakouts.
To improve the odds of success, trade only breakouts that occur in the direction of the prevailing trend before the Asian trading range. You trade this strategy only when the breakout occurs after the London Open, especially in the first 15 minutes.
Here are the steps to follow:
-Identify the direction of the trend: Study your price chart and take note of the direction of the trend. If possible, you may step up to a higher timeframe to get a better picture of the market structure and the most relevant trend for the setup. The trend on the hourly timeframe may be good enough.
-Establish the Asian trading range: Use a time zone indicator, such as the period separator, to mark the time for London Open, or you may use the Cycles Lines to identify the beginning of the trading day and use a vertical line to mark the London Open. Then, use horizontal lines or the rectangle tool to mark the upper and lower boundaries of the Asian session. Do it on the timeframe you trade on.
-Wait for a breakout after London Open: Now, wait for the London market to open and a breakout to occur in the direction of the prevailing trend. If there has been an uptrend before
the Asian range, look for an upward breakout, but if it was a downtrend, look for a downward breakout.
-Enter a trade at the close of the breakout candlestick: Place the appropriate trade when the candlestick that caused the breakout closes — a buy order for an upward breakout and a sell order for a downward breakout.
-Put your stop loss and profit target: You can place your stop loss order beyond the other end of the Asian range or in the middle of the range if it is too big. Alternatively, you may use a time-based stop loss where you get out of the trade if the price hasn’t moved in your favor after one hour. You may also combine price-based and time-based stop loss. For the profit target, you may use twice the size of the Asian range or trail your profit.
Fading the pre-London Open false breakout
This method is quite effective because it can show what the smart money is up to, and it may also have a better reward/risk ratio. The key factor here is that you look for a false breakout during the one hour preceding the London Open (the first hour of the Frankfurt market).
The odds of a successful outcome are higher if the false breakouts occur against the direction of the prevailing trend so that your trade can be in the direction of the trend. Here are the steps to follow when you want to use this method:
-Note the trend direction: From your price chart, establish the direction of the trend. It may require you to move to a higher timeframe to be able to see the broad perspective of the market. This is an intraday trading strategy, so the idea is not to focus on the long-term timeframe but on the most important trend for the intraday setup at that moment. Hence, the trend on the hourly timeframe is fine.
-Mark the boundaries of the Asian trading range: Use the necessary tools to identify the Asian trading session and mark the upper and lower boundaries of the price range during that session with horizontal lines or the rectangle tool. You may use the period separator tool or MarketTime to identify the various trading sessions. On MT4, you may use the Cycle Lines to identify the beginning of the trading day, which starts with the Asian session, but you should use two vertical lines to indicate the Frankfurt Open and the London Open.
-Look for a false breakout in the first hour after the Frankfurt Open: Volatility begins to increase in the hour preceding the London market open. This is a time when European biggest financial institutions and professional traders are looking to fill their orders and take positions for the day. They normally push the price beyond one of the boundaries of the Asian trading range as they seek to trigger stop orders and lure in retail traders to provide them with the liquidity to fill their orders. It is preferable if the false breakout occurs against the trend so that your trade would be in the direction of the trend. Here, there is an uptrend, and we have a downward false breakout.
-Wait for the price to move back into the Asian trading range: By the time the London market opens, check whether the price is reversing, which confirms the false breakout. Now, wait for it to move back into the Asian range, indicating that the smart money was only looking for orders with the initial breakout and would likely move the price the other direction.
-Enter a trade at the close of the candlestick that moved into the range: Once the 5-minute or 15-minute candlestick that re-enters the Asian range closes, enter the appropriate trade at the open of the next candlestick — a buy order if the false breakout was to the downside and a sell order if the false breakout was to the upside. The trade is more likely to work if it matches with the prevailing trend.
-Place your stop loss and profit target: Your stop loss order should be below the lowest point of the false breakout move if you are long or above the highest point of the false breakout move if you are short. Alternatively, you may use a time-based stop loss and get out of the trade if the price hasn’t moved in your favor after one hour. It is also possible to combine price-based stop loss with time-based stop loss, in which case the condition that is first met takes you out of the trade. For your profit target, it is fine to use twice the size of the Asian range or simply a 2:1 or 3: 1 reward/risk ratio. You may also trail your profit if you want.
The benefits of trading the London breakout trading strategy
The London breakout trading strategy offers a number of advantages. One of them is that it is a simple strategy and very easy to implement. You don’t need to use any complicated technical indicator or tool, apart from the horizontal line or rectangle tool you use to establish the boundaries of the Asian trading range. It may be necessary to install a time-zone indicator if you can’t identify the time of London open on your chart. Aside from these simple tools, you don’t need any special indicator analysis.
Another advantage is that you can easily make use of a 2:1 reward/risk ratio for profit target and stop loss order, or you may use twice the size of the Asian trading range as your profit target while using a time-based stop loss rather than a price-based one.
Furthermore, the strategy offers a fairly reliable way to make quick profits if you know what you are doing. The key is to follow a simple trading process.
Disadvantages of trading the London breakout trading strategy
Despite how simple and reliable the trading strategy is, it is not the trading Holy Grail. Of course, there is nothing of a sort in the trading world. As with other trading systems, the London breakout trading strategy can give some losing trades. But this is not a disadvantage per se.
The primary disadvantage of the trading strategy is that, on some days, high-impact economic data are released around the period of the market open, which can drive the volatility exceptionally high, and the market may become quite choppy, without any opportunity to make a reasonable profit.
Moreover, if your broker is using variable spreads, the spreads may increase by a lot during this high volatility period. Some brokers with fixed spreads may also widen their spreads during such periods. If there are too many high-impact economic data releases during London opening hours, it may be advisable not to trade the market at that time.
The London breakout trading strategy is a very simple method to trade some currency pairs around the period of the London market open, which is associated with high volatility and liquidity because of the volume of interbank trading activities during that period. It is based on understanding the different time zones and trading the breakout of the Asian trading range.