A breakout occurs when the price breaks a certain level of the forex market. These levels can be support and resistance, trend line, uptrend, downtrend, etc. And a break on these levels could give us an indication to trade the forex market.
A fakeout breaks the level too, but the breakout could be “fake”. When the price breaks a resistance or support zone that’s a breakout. And it gives us a signal to trade the support or resistance level since the breakout occurred.
But the breakout scenario can be fake and the price could go in the previous price level, and form a fake breakout.
So in this article, we will show you how to detect and trade a breakout and false breakouts in the forex market.
How to trade breakouts?
As we mentioned at the beginning of the article, a breakout occurs when the price breaks support, resistance, trend line, etc. In this example, we’re showing you a breakout of a trend line and a resistance. On the image below we have a chart of the currency pair XAA/USD.
The chart shows a downtrend (bearish momentum) that’s drawn with a trend line and a strong resistance zone that in the past has acted as a support zone.
This resistance zone could be decisive in the next movement of the foreign exchange market. A break of the trendline and the resistance zone could give us a great opportunity to trade this break. Let’s see what happens next if the price will be able to break the resistance and the trendline.
As you can see the price has broken the major resistance zone. Also, the trendline has been broken too and the candle closed above the trendline and resistance zone. This is an example of a breakout in the forex market. A buy order where the bullish candle was closed, could give us some pips in the forex market.
How to trade fakeouts?
Not all of the breakouts are valid, as some breakout can be false too. These are called fake breakouts and many traders fall for fake breakouts as they trade breakouts, thinking that each breakout will change the direction. False breakouts, not all the time are valid breakouts and can move in the opposite direction.
Below on the image chart, we have drawn support and 4 arrows. The support zone at 1.84908 is a strong support zone and this support zone has been tested 3-4 times but the support didn’t break. We also have the white arrows that show where support was tested. And we have the yellow arrow that shows where the fake breakout occurred.
Fakeouts don’t occur so often, but when a fakeout occurs then you may not have any other option but to accept the loss. If you would have entered on a sell just below the close of the candle at the support zone, then you’d get caught up from the fakeout. But a stop loss could have saved a further loss on the trade and your stop loss should be placed just a bit above the 1.84908 level.
The trade could end on a loss but you would have lost only 20-30 pips maximum. With proper risk management, you could protect your account in these situations where fake breakouts occur in the financial market. If a fakeout occurs in the financial markets, as the situation with the example above, then you could use that opportunity to trade.
When the fake breakout occurred, a bullish engulfing candle was formed by changing the price from a bearish movement to a bullish movement in the market. And since the candle closed bullish, you could have traded a breakout strategy with a buy order.
The examples in this article explained how to detect a breakout on the market and use the opportunity to trade the breakout. We also explained how to identify and trade a fake breakout (fakeout) in the forex market.
You should use these lesson examples to learn how to identify breakouts and fakeouts. Most of the forex traders try to trade each breakout point with short positions or long positions as they think it’s a bullish signal or bearish signals.
By trading each fakeout you may think that price will always go back where it was before. And by trading on away like that, you could end your trades on losses. So, doing a proper analysis of the market before trading fakeouts and breakouts in the market is recommended.