When trading breakouts in forex, it is important to realize that there are two main types:
- Continuation breakouts
- Reversal breakouts
Knowing what type of breakout you are seeing will help you make sense of what is actually happening in the big picture of the market.
Breakouts are significant because they indicate a change in the supply and demand of the currency pair you are trading. This change in sentiment can cause extensive moves that provide excellent opportunities for you to grab some pips.
Sometimes when there is an extensive move in one direction the market will often take a breather. This occurs when buyers and sellers pause to see what they should do next. As a result, you will see a period of range-bound movement called consolidation.
If traders decide that the initial trend was the right decision, and continue to push the price in the same direction, the result is a continuation breakout. Just think of it as a “continuation” of the initial trend…. You’re so smart!
Reversal breakouts start off the same way as continuation breakouts in the fact that after a long trend, there tends to be a pause or consolidation.
The only difference is that after this consolidation, forex traders decide that the trend is exhausted and push the price in the opposite or “reverse” direction. As a result, you have what is called a “reversal breakout”. You catch on quick!
Now we know by now you are super excited to start trading breakouts (please tell us you haven’t already started trading!) but you also have to be careful. Just like Lionel Messi can fake out defenders, the market can fake you out as well produce false breakouts.
False breakouts occur when the price breaks past a certain level (support, resistance, triangle, trend line, etc.) but doesn’t continue to accelerate in that direction. Instead, what you might’ve seen was a short spike followed by the price moving back into its trading range.
A good way to enter on a breakout is to wait until the price retraces back to the original breakout level and then wait to see if it bounces back to create a new high or low (depending on which direction you are trading).
Another way to combat fake outs is by not taking the first breakout you see. By waiting to see if the price will continue to move in your intended direction, you give yourself a better chance of taking a profitable trade. The downside to this is that you may miss out on some trades in which the price moves quickly without any hesitation.