Heartache with false breakouts can be a devastating hit for your trading account and for your confidence. In this video, Jeff Holden, head of Trader Development at SB, shares his technique for avoiding them and the frustration that accompanies such losing trades.
Step 1: Understand the Importance of Identifying False Breakouts
This video isn’t about making a bunch of extra money but is instead about saving you from entering false breakouts. At the end, we will discuss an opportunity that arises specifically from these false breakouts. The focus here is to get into the right trades, let them develop correctly, and sidestep those costly false breakout opportunities.
Step 2: The Breakout Experience and Its Impact
One of the worst experiences I had after joining the firm was a breakout trade that initially looked perfect. All the variables seemed right: the consolidation, the time spent consolidating, the volume, and the height of the range. It seemed like the perfect setup. As soon as I put the trade on, the breakout began, and it initially went up quickly. I thought it was going to work even better than I anticipated.
But like it was, just when the trade turned, I became stuck and was unable to take the unexpected price action into account, for the fact was, my own overconfidence. Thanks God, I had my stop on the way out, so the bad news turned into not as terrible news, but I never learned much about trading without such experiences: how to sidestep a failed breakout.
Step 3: Breakouts and Breakdowns: Definitions
A breakout usually happens after a range has been established with multiple touches on both sides. The breakout is supposed to resolve this range with significant momentum. But not all breakouts are what they appear to be. According to studies, about 60% of breakouts retest, and 30-40% fail outright. It is important to understand these statistics in order to know when a breakout is more likely to fail.
Step 4: Key Factors That Lead to False Breakouts
Subtle Clues to Identify False Breakouts
- Too Many Touches: If a range has too many touches on either side, the pressure may be too great, and the breakout becomes more likely to fail.
- Ranging Breakouts: If a breakout occurs from a range without an increase in volume, it’s likely to fail.
- Extended Breakouts: If the price moves too far before consolidating and resuming, then the breakout will probably fail unless supported by heavy volume.
Understanding these factors helps us know when to be more cautious. If we can identify these subtle signs, then we can adjust our risk expectations or simply wait for a better setup.
Step 5: How to Avoid False Breakouts
The pre-requisites for false breakouts would include recognizing which conditions are most vulnerable to failure. For example, breakouts with excessive pressure (too many wicks) or those which lack enough volume need to be viewed with a marked degree of caution.
This phase is crucial – the consolidation before the breakout. A great breakout happens when the pressure accumulates on the other side of the breakout range. Success is also maximized by using multiple time frames that agree with the breakout.
Step 6: Price Action After Breakout Monitoring
Once a breakout happens, it is vital to observe the following five bars or candlesticks. These bars will let you know if the breakout is sustainable or more likely to fail. If there is aggressive or passive participation on these bars, it is a good sign that the breakout might last.
Do not take action when you see indecisive or lethargic participation. These are signs that the breakout is going to fail.
Step 7: Standing, Adding, or Folding
At this point, you will see the first few bars after the breakout. There are three choices in front of you:
- Stand: When you see a kind of passive buying, then hold the position and let the market continue. When the setup is good, do not add risk.
- Add: When aggressive buying comes in, you can bet that the price is going to keep moving in your favor. You can then add to your position by taking a stop down below the consolidation.
- Fold: If you’re seeing indecisive or lethargic participation, it’s time to get out of the trade and not participate in a failed breakout.
Step 8: Importance of Breakout Mechanics
By understanding the mechanics of breakouts and recognizing the signs of potential failures, you can greatly reduce the chances of entering into a losing position. This technique focuses on stacking the odds in your favor by observing key metrics such as volume, price action, and multiple time frame alignment.
Remember, not every breakout is worth entering. By applying these principles, you can sidestep false breakouts and improve your overall trading performance.