Often there are times in the market when the price breaks a certain significant level, and most of the novice traders immediately jump into the market. But, suddenly, the price reverts quickly, stopping out these traders or putting them in a losing position. Most of the experienced traders would have exited their positions when they realized they are trapped by the big whales like industry or institutional traders.
But beginner traders often become the victims of these false breakouts, and it affects their psychology as well. They will start doubting their trading strategies, and the fear element will surpass their confidence. Instead of falling into the negative state of mind, traders should learn how to use these false breakouts to their advantage so that they can profit from it. In this article, let’s discuss how to trade the false breakouts properly.
Most of the traders often consider false breakouts as a negative thing in the market. The general perception is that, by trading the false breakouts, they are taking the unnecessary risk, or it is not the correct way to trade. Some traders also believe that simple breakouts are more comfortable to trade. It is true, but simple breakouts won’t provide a great risk-reward, and also, it is not a consistent way to trade the market. On the other hand, successful & experienced traders see the false breakout logically and consider it as an opportunity to make some quick profits.
There are a lot of ways to trade false breakouts. Some traders trade them in conjunction with indicators, and some use it with trend lines and support resistance. In this strategy, we will show you the most appropriate way of trading false breakouts.
Trading the false breakout by using the major S&R levels
False breakouts occur in all types of markets, such as Forex, Stocks, Futures, and Options. They also occur in all kinds of market conditions. But the critical thing to remember is that every false break out is not worthy enough to trade. Always consider trading the false breakouts by following the trend of the market. That is, if the trend is up, look for the buy-side false breakout and in a downtrend, look for sell-side false breakouts.
Step 1 – Find the trend of the higher timeframe
This step is simple yet crucial because we need to confirm the trend of the market. Keep in mind that most of the lower timeframes always follow the direction of the higher timeframe. To explain this strategy, we are examining the uptrend of the GBP/USD forex pair.
Step 2 – Look for the significant S&R in the lower timeframe
Most of the false breakouts occur near the support and resistance level. The reason brokers and market movers use these levels is to manipulate the market as is these areas act as a significant supply-demand zone. This makes it easier for the bigger players to fill more orders.
Step 3 – Look for the false breakouts at the S&R level
As we know by now, most of the false breakouts happen at major support resistance area. A trader can set the alarm on the price chart to see when the price action is at a major level. When the price breaks these levels, wait for the false breakout to trade the market.
In the below image, GBP/USD was in an uptrend. On 15 Min chart during the pullback phase, prices started holding at the support area. On 29th Nov, look at the first circle where the price action prints the false breakout. But there is no way to trade that breakout. Because after that, the price action dipped below the support area, which is a sign of a false breakout. So it is an indication to go long on the GBP/USD forex pair.
Step 4 – Entry, Stop loss and Take profit
A trader should be entering the market when the price action holds at the significant support resistance area as it confirms that the levels are active to hold the prices. \
Take profit placement depends on your trading style. If you are an intraday trader, we suggest you close your position at a recent high. If you are a swing trader, look for another false breakout to load more positions. You can also use the recent high or any support resistance area of the higher timeframe to close all of your positions.
Most of the false breakouts are sure shot trades in the market. Place the stop loss just below the recent low, or at the closing of the most recent candle. If you are a conservative trader, then put stop loss bit spacious to your entry point.
In the below image, we have placed the stop loss just below the closing of the recent candle, and we have captured the 4R trade in the market.
It is essential to learn the logic and psychology behind any false breakout. Most of the time, the risk is small in these types of trades, and it is important not to be greedy while placing more extended targets. If there is no momentum in the market, close your positions, and if the trend is healthy to go for longer moves. You can still trade the regular breakouts, but throw relatively less money when compared to the false breakout trades. Also, make sure to practice trading false breakouts in a demo account until you master it. We hope you liked this article. Cheers!