4 Ways To Avoid False Breakout

Introduction

What is false breakout?

False breakout is a breakout failure.  

In trading, we always will look at the breakout from the support or resistance level to ensure the trend is continuing or reverse. If we can know the breakout is real or not, then we will have higher win rate.

That’s mean if we avoid more false breakout, we may have a higher win rate and thus become a better trader.

 

Area in Support and Resistance Line

At here I wish to include some information about support and resistance lines. Support and resistance line may not be exactly the level of support or resistance. Because the lines are drawn by us but the market are the one who really decide where is the actual level.

So…

When the price breakout from a pattern, the breakout point or level we normally look at are the lines drawn on top and bottom of the price as the pattern. 

But the line might not be the exactly the resistance or support level of the price.

The actual resistance and support level of the price is the area AROUND the lines.

Breakout Failure

You can see that the orange color around the resistance line of the pattern is the actual Resistance Area.

After a small breakout, the price retrench back into the pattern and then break the pattern in the other direction.

With this understanding of the area of support and resistance, we can know that false breakout will always be happening.

So, we need to take certain steps to increase our success rate.

Below are the steps that I tried and they are very useful along my trading and learning journey.

The first and the most important is…

 

#1 Be patient

Patience is the gold in trading.

When I’m new to trading, I have the urge to trade.

I have less patience to wait for the breakout.

At that time, in my mind, I’m thinking that if I’m hard working in trading, that means I need to trade more.

But this is not true.

When I want to trade more, I tend to loosen my trading rules and chasing for quantity of trades and not quality of every trade.

In the end, I have a bunch of losses.

You don’t want to be like me. So, be patient and wait for the signal and following your trading plan.

You trading strategy may not suit to trade in all market conditions. But there are maybe one or two market conditions that normally your trade on. 

The things you need to do using your strategy is just waiting for the signals to appear and trade only according to the signals.

Patience takes hard work.

Waiting for the signals and keep analyze the chart takes time and mental energy.

Trading will draining your mental energy, your hard work is in the form of mental energy.

Just like the 20/80 principle

More than 80% of the time is taken to waiting for the signal and analysing the chart, less than 20% of the time to placing and managing the trades

https://www.instagram.com/p/B1ogtOrF26E/

Be patient and be prepared.

 

#2 Enter The Market After Retrenchment Of Breakout

When your trading strategy include trade at the breakout, then this is useful to you.

The easiest thing to do is to wait for the retrenchment after the breakout.

When the price just break the pattern’s support or resistance line, there is a high chance that the price will bounce back into the pattern again.

After the retrenchment, we can know that the breakout is a real breakout out or not.

Successful Breakout

As you can see in the above diagram, the price break through the resistance line and then having a retrenchment back on the line of resistance before the price continue to go upward. 

This can prove that the price has a strong “force” to move up and we then can enter the market after the bounce back of the breakout retrenchment.

Below is the real-world chart example for the retrenchment after a successful breakout.

Retrenchment After Breakout

On the other hand, if it is a fake breakout,

the price will retrench back quickly to the pattern after it breaks it.

Fake Breakout

The price in the diagram above is breaking the resistance in the forth time it touch the resistance.

But after the breaking, the price retrench back under the resistance level.

From the two sketch diagram, we can know that waiting for retrenchment after the breakout is important for avoiding the false breakout.

For the real life example of false breakout, it will be look similar like this…

False Breakout

Waiting for retrenchment need to have more patience than waiting for the breakout. 

But in the end, it can help you to minimize your unsuccessful trades.

 

#3 Use indicator and oscillator to identify

Do you use indicator or oscillator in your trading plan?

With good use of indicator and oscillator can help you to know the market better than just the lines.

The most simple indicator you can use is the Moving Average.

After the breakout, you can wait for the Moving Average to cross over the price before you enter.

Crossing of Moving Average After Breakout

In the diagram, you can see that after the price breakout from the pattern, we can wait for the Smaller-Period Moving Average to cross over the larger one.

When the price breakout of the pattern, that is the first signal the price will go up. Then the crossing of the Moving Average is the second signal.

It is like a double confirm for the breakout.

When we wait for that, we will have a higher chance to know the that the breakout is a success.

Other than that, you can try to use oscillators to help you to know the condition of the market.

Many oscillators will let you know that the market was oversold or overbought.

When the market oversold and breakout the pattern or support, you would need to think again before Short (selling) a trade.

Vise versa, when the market is overbought, there are higher possibility the price will go down. Even the price has a break out and go up, the chances the price fallen back into the pattern is high. 

After Breakout Oscillator

In the diagram, the price is breaking the resistance line at first but the oscillator have some draw back. When the price break the resistance again, the oscillator shows the trend of slowly going to the overbought level.

This shows that the oscillator is telling us the price will increase since the lines of oscillator slowly moving away from the oversold region, toward the overbought region.

 

#4 Analyze the chart using a larger time frame chart

Larger time frame support and resistance and pattern always have a stronger “force” that will affect the price than the smaller time frame.

E.g. when you see the price break the pattern but the larger time frame shows you a resistance near the breakout of the pattern. The chances that the breakout will be a failure is very high.

The stronger “force” will hold the price under a larger-time-frame’s resistance level. 

Weak And Strong Support

From above, you can see that the price breakout from the weaker but bounce back after it hit the stronger support line.

For me, it is better to analyze a larger time frame before you analyze the time frame you usually look at.  

E.g. If you are normally trade on 1-hour time frame, you can analyze for the 4-hour time frame before you look at the 1-hour time frame. If 15-minutes time frame, then look at 1-hour time frame first.

You just have to know where are support and resistance levels for the larger time frame to increase your win rate.

 

Conclusion

Avoid the false breakout in trading is important to increase the win rate. Eliminating the false breakout can enhance our trading plan and give us a better trading result.

I hope you can consider to implement these ideas into your trading plan.

I’m sure it will be very useful to you.

The most important thing mentioned above is to be patient – one of a behavior a trader must learn.

Lastly, if you have other methods to handle the false breakout, please share at below. Let us learn together and become a better trader.

 

Thanks for spending your precious time together.

Let us grow and learn together.

Cheers,

Jordan V.

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