Well, everyone would know what a breakout is. Breakouts are very popular in the trading industry. There are many types of breakouts, and there are many ways to trade with it as well. Most traders take a trade once the breakout happens, while a price action trader, who’s always ahead of the game, enters the trade before the breakout.
There are different kinds of breakouts in the market. For example, a breakout can happen from a range, Support and Resistance level, Supply and Demand level, and candlestick patterns. So, isn’t this practically everything in the market? Trading breakout is not a specific thing, instead is a specific style, which means you can trade a breakout trade anytime, depending on the way you read the market.
The most important question that needs to be answered is, is the breakout real or fake? Most of the traders wait for the market to show the direction, i.e., they wait for the price to break out, and that’s when they take action. And later, the breakout ends up being a faker. This happens several times. Therefore, understanding the legitimacy of the breakout is very crucial.
Drawing True Support and Resistance
The essential prerequisite required to trade a breakout is to understand how to draw true support and resistance. Therefore, it is recommended to read the article on support and resistance first and then proceed with this article.
Difference between price action & non-price action traders while trading breakout
Well, there are tons of strategies out there to trade breakouts. Some traders enter the trade immediately after the price breaks outs from a range or trend line, while some traders enter once the price retraces back after the breakout. However, in all of these trades, there is no guarantee that the price will move in the trader’s direction.
Coming to price actions traders, breakouts are just additional bonuses for them. They enter the trade much before the breakout happens, which means that they are already sitting with some profits in hand. And, they often extract some profits around the breakout region because if the price does not break out, they would at least go away with some profit. Or if the price does breakout, this would increase the existing profit of the trader.
So, here’s the thing. The point where the price action traders exit some of their positions, other traders enter the trade. In other words, one set of traders are buying, and the other set of traders are selling or vice versa.
Complete trade analysis
In the example given below, we can clearly see that the market is in an uptrend. The orange line represents the support and resistance level. Since the large players are buyers, even we should be looking only for buys.
The price reaches up to 0.85864 and begins to pull back. It pulls back until 0.85700 and again shoots up. However, it does try to make a higher high but fails.
When the price breaks, the 0.85864 many traders go for the buys thinking that the trend is going to continue. But, they get hit with a stop loss. This is because there is no logic for the price to make a higher high.
Moving forward, the price starts to hold at 0.85789. The same move repeats again, i.e., the price goes to the 0.858664 and comes back down. Therefore we can say that the market is ranging.
After ranging for a couple more times, the price breaks down from the range. This is when many breakout traders jump in for a sell. But, smart traders do not take the sell because they know that buyers are in control of the market. Once the price breaks down and touches the S&R (orange ray), the buyers come up strong, indicating that the buyers are still alive. The buyers then start to hold at the bottom of the range. This is where the other set of traders who were waiting for the price to pullback after the breakout, enter for a sell.
This region is called the money making region. Because this the point where some traders are looking at it as a sell and some traders (price action) are looking to go long. Since we analyzed the market with the correct logic; we can expect the prices to head north.
Assuming we entered for a buy around the bottom of the range, our first target would be the top of the range because the market dropped every time it reached that price. This is where we extract some money out of the trade and move the stop loss to breakeven. By doing this, our trade becomes completely risk-free. Even if the price drops and hits the stop loss, we would go away with some profits.
On the other hand, other traders enter for a buy after the price breaks the top of the range. Now, there is only a 50% probability of the trade to perform, which puts their trade at high risk. This time the trade did favour the range breakout traders as well. However, not always will it be in their favour. An example supporting the statement is given below.
Here in this example, we can see that the market is overall in an uptrend, and currently, the prices are ranging. At one point in time, the price breaks above the range with a large green candle. This entices many traders to trigger the buy button.
Once they are in the buy, the prices suddenly drop. In fact, it falls below the support as well. This then sparks their stop loss too. In case of price action traders, their stop loss is triggered as well, but, they don’t incur a loss, instead go away with some gains.
The above trades explain the interpretation of different types of traders for trading a breakout. Not all set of price action traders trade a breakout in this manner. There are other ways, as well.
The above-mentioned example is one of the professional ways to do it. Basically, trading a breakout is more like money management than a specific strategy. Therefore, to improve consistency in your trading, use the breakout concept as a powerful money management tool rather than looking out for strategies based on it.