Hello guys, in the following minutes I willshow you a simple but powerful trading strategy that will help you to take advantage of failedbreakouts.
As you probably know, one of the classic rulesof support and resistance is that support, once violated, becomes resistance and conversely, resistance, once violated, becomes support.
We can find many examples of this principlein real market action.
This chart shows a classic example where aresistance level held at point A, was broken at point B, and then held cleanly as supporton a retest at point C.
This chart shows another example where previoussupport was broken, but then held as resistance on the next retests.
These are textbook examples of price actionaround support and resistance levels, but there is one small problem.
Only 15%-20% of these price moves are valid, and the rest ones are simply failed or fake breakouts.
A false breakout is when price moves beyondthe previously established price range but then retreats back to within the range.
Since a range is basically a battle betweenbuyers and sellers pushing in opposite directions, these false breakouts often occur becausesupport and resistance are not 100% accurate.
Here’s a harsh truth: for most novice traders, trading breakouts will be a losing strategy.
The trading reality is that explosive gainsare quite rare considering the many potential ranges available to trade, and even if youanticipate the breakout correctly, you will still face problems with maintain the position.
But while a range breakout may be difficultto trade profitably for many traders, there are alternatives using the same chart patternthat give the trader a better chance at success.
This is the pattern that we will try to spoton our charts and here’s the logic supporting this strategy.
Markets hunt for stop orders and activitybeyond significant price levels.
Many times, there is no real conviction behindthese moves, and the price moves fail and reverse quickly once the stop orders are triggered.
If this breakout occurs and fails, there willbe many trapped traders, which can add momentum to the opposite direction from that level.
Entering after such a move allows for excellentreward/risk potential with a clearly defined risk point.
The best examples of this trade occur in extendedranges, and will usually be accompanied by a momentum divergence on the trading timeframe.
In this example, for a short entry, the markettrades above a clearly defined resistance area, but immediately reverses on the followingbars and closes back under the resistance.
There can be significant volatility, volume, and activity on the breakout, but there should be no real continuation beyond the level.
The final confirmation of the fake breakoutis the momentum divergence Here’s another example.
We have a clear support, the price being unableto continue lower.
Point A marks a brief breach below support, but immediately closed back above the support level.
Once the movement was confirmed by the divergence, the wiser trade would be a long trade, instead of chasing the failed breakout.
On the XX chart, we found this pattern onceagain.
The price attempted to break to new highs, but there was not enough buying pressure to hold it above the resistance level and itfailed on the same day.
The divergence was there, so the higher probabilitytrade would be on the short side.
This charts shows another classic exampleof a fake breakout.
After the resistance was broken to the upside, the first instinct is to “go long” for a continued trend run above the previous highs, but the market actually closed below the resistance level and reversed.
When we trade this setup, the stop is clearlydefined: just beyond the extreme of fake breakout.
Because this is an aggressive countertrendtrade, it is important to not add to losing trades or widen the stops.
So, respect the stop level without question.
In what concerns the profit taking, allowyourself to take partial profits as the market makes them available to you.
For instance, one plan would be to take profiton the first part when the profit equals the initial risk on the trade, meaning a 1 to1 ratio.
The profit target on the second portion isdiscretionary.
I prefer to swing trade with this setup butthis pattern also suits scalping.
You will find many false breakouts on the1-min charts, you just have to manage your trades accordingly.
The beauty of this failed breakout techniqueis the fact that there is no subjectivity in stop location and little subjectivity inmanaging losing trades—if the market makes a new extreme, then you are wrong and mustexit the trade.
Here’s an important observation.
Ideally, the market should not be able toconsolidate near the level.
Consolidation near the level is more consistentwith a continuation of the existing trend.
If the failed breakout is successful, priceshould move sharply away from the level.
Once you find yourself in a trade where theprice doesn’t moves or stagnates for too long around the entry points, cut your losses, exit the trade and search for better trades, with hopefully more momentum behind them.
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Until next time.