FOREX STRATEGY: BREAKOUT TRADING STRATEGY PART 2
The Breakout trading strategy is based on taking positions when the price
breaks a resistance or support level on a financial market, for example the
Forex. This is called a breakout and if the price balancing continues it can
turn out to be a very lucrative trade.
Why breakout trading strategies are not the holy grail of forex strategy,
not the ultimate forex system? The answer is obvious: not all breakouts
continue.
In fact, breakouts do not continue regularly. So-called 'false breakouts'
break through resistance or support levels, but do not know how to keep the run
going. For some forex traders, a break is a break when it comes to a resistance
/ support level, but most traders do not look at a pip more or less and want to
see more than a 'technical' break.
For example, if the EUR / USD has not been able to get past the 1,4448
twice before, and the third time there is a spike that reaches 1,4451, is
resistance broken at that time? Technically perhaps, but in practice the
resistance level will often still work because many traders take reverse
positions if resistance / support is broken, or against the direction of the
breakout. Trading strategies based on this are called breakout fading. (more
about this in 'forex strategy: Breakout Trading Strategy Part 3).
You obviously do not want to take a position that is meant to take advantage
of a breakout if many of those breakouts turn out to be false breakouts. It is
therefore wise to first test whether a breakout is 'real'. Here are two common
methods for: 1) Secondary resistance / support levels 2) role reversals
Put simply, Secondary resistance / support levels are nothing more than
defining a second line of defense that the price must also break through before
breaking the first level is considered successful. Study the prices on the
forex charts that you use for your trading strategy. If you are an intra day
trader who does not keep positions open for much longer than an hour, for
example, the 5 minute candles forex chart is the most obvious way to study the
price movement. View the forex chart for the currency pair in which you want to
take a position and decide how far the course should go beyond a resistance /
support level before there is a big chance that there will be a real breakout.
For example, for an intra day trade on the EUR / USD this is 10/15 pips beyond
the predefined resistance / support level.
Role Reversal is changing a
(broken) resistance level in a support level and a (broken) support level in a
resistance level. The thought is as simple as elegant. If the price breaks
through a certain resistance level, the former resistance level automatically
becomes a new support level. If the price falls back but the (new) support
level does not break, that is a sign that the breakout is real; the price does
not really return to the level before the breakout. It happens regularly that
the prize struggles several times with the new support (former resistance)
level, but every time there is a bounce off - such as a drop in the price at
the moment the support level is hit or almost hit - is that a stronger sign
that there is a new support level present and that the break out is real (of
course the reverse is true if the breakout is down, and the price is shot by a
support level.) The old suport level will be the new resistance level).
In the third and final part about Forex breakout strategy we look at
breakout fading strategies.
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