Breakouts are a common phenomenon in the forex market and occur across different chart intervals. It is therefore no surprise that break out trading strategies have become one of the most popular ways of trading forex, besides other strategies such as trend following methods. In order to trade break outs successfully traders need to first understand what causes the break outs, how to identify the breakouts and finally learn the various ways they can trade forex break outs.
Trading breakouts is not a new concept; traders have been using breakouts for centuries. Today many of the world’s top traders trade breakouts for big profits. So what actually is a breakout? A breakout is the point at which the market price breaks away, or moves out of a trading range. The trading range can be for any length of time but once prices exceeds the high or low of the range, a breakout has occurred. The accepted market wisdom is “buy low sell high”.
Breakouts can either represent a continuation of the trend, after a period of consolidation which results in the formation of a rectangle chart pattern or at the end of a move higher or lower as a reversal. They can be seen on most timeframes and often result in price moving sharply higher or lower as either bulls or bears finally get the upper-hand. The general rule of breakout trading is that the longer the period of consolidation the more powerful the breakout is likely to be.
There are a number of methods to trade breakouts and many of these agree that the breakout needs to be confirmed in order to avoid a “false breakout” situation. When the breakout setup shows for example a rectangle pattern, with both highs and lows forming horizontal support and resistance lines, traders will wait for either level to be broken. This will provide the entry either directly at the high of the breakout price bar or, as many forex traders prefer, after the first pull back following the breakout.
Strategies that are likely to provide traders with more success involve being patient and waiting for the breakout to happen, then trading the trend if it occurs, or waiting for a correction and seeing if the price resumes the breakout direction. With a good defined risk/reward ratio is most cases, break outs can become easy to trade with enough practice and understanding of various aspects such as trend lines, channels, support and resistance.