The breakout strategy is a trading strategy in which positions are taken when the price breaks through a
resistance or support level. There are many different breakout strategies and they are used in all financial
markets, including the currency market (ie the forex market).
The breakout strategy is very popular with novice Forex traders, because it makes logical sense (and
therefore easy to understand) and easy to implement. The basic idea is to take the position at the moment
that the price starts trading outside the channel where he moved in until then. A well-known technical indicator
that is often used for the breakout strategy is the Bollinger Bands. When the price breaks the upper or lower
Bollinger Band, it is seen as an increased chance of a breakout.
In the breakout strategy in its simplest form, the trader places a buy stop or a sell stop, respectively above
the resistance or below the support level. A buy stop is an order for a long position that is only opened when
a certain price is hit. Sell order works the same, but then as a short position that is opened when a certain price
is hit.
Example of a breakout strategy: The currency pair EUR / USD has moved in the range of 1,400 and 1,4500
on the Forex in recent days. The 1.4500 shows an important resistance level and the 1,4300 an important
support level. The forex trader now places a buy stop order on the 1,4505 and a sell stop on 1.4295. This
means that if the price breaks the 1.4500 and hits the 1.4505, a long position is opened that can take full
advantage of the breakout upwards. The same thing when the price breaks down through the 1,4300 and hits
the 1.4295; in that case, a short position would be opened to take advantage of the breakout downwards.
Types of Breakouts
There are two types of breakouts, the continuation breakout
and the reversal breakout.
Continuation breakout: this is when the price re-moves in
the direction in which it moved before a period of consolidation occurred.
Think of a temporary range trade while buyers and sellers close their positions
and try to figure out which way the price will move.
Reversal breakout: This is the kind of breakout that
triggers a real trend reversal, ie the price breaks with the previous trend and
starts to reverse in the opposite direction. This is usually triggered by
fundamental causes.
Logically, the reversal breakout is rarer than the
continuation breakout, simply because trend reversals occur less often than
continuing a trend.
Breakout strategies are
available in all shapes and sizes. An intra day trader can therefore just as
well use a breakout strategy as a long-term trader, who takes forex positions
for months or even years.
The point is that the price of the currency pair has left
the range within which he moved in a certain period. To determine the range you
need to look at resistance and support levels within which the price moves.
There are different ways of gaining insight into resistance and support levels
(scouring online resources, or calculating yourself, for example calculating
fibonacci levels, what are fibonacci levels), but the most simple way of
calculating resistance and support can be done by anyone.
You take a forex chart, for example a graph of the EUR /
USD, with 15 minute candles. This is a graph on which a candle is published for
every 15 minutes. (more about candlestick charts). Now look at what the high
was and what the low was for a period of 4 hours, and whether these levels were
approached several times (that is, if the price was up to grades between these
levels). If so, you can say that the short-term resistance and support levels
are formed by the respective high and low. When the high or the low is broken,
there is an intra-day breakout.
Why also the forex breakout strategy is not the holy
grail with which every forex trader becomes dormant? More about this in ForexStrategy: Breakout Trading Strategy Part 2
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