Trading breakouts is an excellent trading strategy that involves buying or selling an asset after a long period of consolidation. Most successful day traders know how to identify these breakouts and ride the new trend until the next trend is formed.
However, the biggest risk of trading a breakout is when the price suddenly reverses, in what is known as a false breakout. In this report, we will look at what false breakouts are, how you can identify them, and how you can use them in the market.
Not the usual acne breakouts
A false breakout happens when there are no enough bulls or bears to continue supporting the asset. In the example above, the lower false breakout happened when bears found strong resistance from bulls.
Similarly, the upper false breakouts happened because there were no enough bulls to continue pushing the price higher.
There are two primary types of a false breakout:
Bull trap – This happens when the price crosses a key resistance and then pulls back after a short while.
Bear trap – This happens in a bearish trend when the price moves below a key support and then returns to the channel.
Bull & bear traps
How To Avoid A False Breakout
1. Embrace patience
First, you should be patient whenever you see a breakout happening. Instead of opening a trade right away, wait for a confirmation signal and then enter a trade.
Depending on your trading timeframes, this waiting process can take a substantial amount of time. For example, if you are trading on a 1-minute chart, you just need to wait for a few minutes to confirm this. On the other hand, if you are trading on a daily chart, you should wait for a few days.
2. Stops
Second, always protect your trades using a trailing stop-loss or a fixed stop-loss and a take-profit. These tools will stop your trades when the trades reach pre-determined levels and protect you from major drawdowns.
3. Other strategies
Third, use charting tools to identify false breakouts. Some of the popular tools that can help you on this are Andrews Pitchfork and Fibonacci Retracements.
Fourth, always focus on the asset’s volume. In most cases, a false breakout happens when it happens in a low-volume environment.
Finally, my favourite is to cross check against other major tickers such as AAPL, MSFT, META, JPM as well as VIX as counter directional when trading S&P 500.
Waited 30 mins for the reversal to short
False breakouts happen all the time in the financial market. Whenever they do, most traders who don’t know much about them tend to lose a lot of money. Unfortunately, identifying these breakouts is not an easy task. However, following the strategies mentioned above can help you avoid making these mistakes.
⚠️ Trading Tips: Breakout will plunge TSLA to 170, 163.5, 154.8 if non-farm payroll and CPI reading turn out too hot for the market to handle by next week. Looking at calls above 173 and puts under 170 on Friday. Trade safe with stop-loss in place.
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