How To Implement A Breakout Trading Strategy

breakout trading strategy

Of the many different approaches designed to trade on Foreign exchange, breakout trading remains one of the most popular. It offers both the potential for high profits to be made and provides a relatively simple approach to trading which is easily implemented.

The concept behind breakout trading strategies amounts to what is essentially a momentum based approach to trading. They are used to capture accelerated price movements in the early stages of a trend, once a price has moved ‘beyond an identifiable trading range or level‘. Following the break, momentum is anticipated to continue and propel the currency pair into a new range. It is this move that the trader seeks to capture.

There are many ways to reference the breakout level. Typically chart patterns and  previous highs or lows can be used to define the ‘breakout point’. In fact just about any identified range that has constrained prior price action can be used, an example being a box breakout strategy which may indicate where a break may occur.

There are several benefit to adopting this approach to the markets. Perhaps the key one is that it allows the trader to prepare themselves prior to a move actually happening. Stop and profit levels can as a result be worked out calmly and placed prior to any anticipated move.

When To Trade Forex Breakouts

Breakouts occur in all market environments and across all time frames. This makes them a very flexible strategy to use. They will work best when both the volume in the market and volatility are high. Breakouts require increased market momentum for success. Once sufficient momentum as achieved the breakout will happen and successful breach the identified level.

A common time to look for breakouts is at the opening of a Forex trading session. At this point in the day the conditions required for a successful execution of this method tend to be present. Market volume and  volatility tend to be at their highest point in the day or after news. At these points the level of activity in the market is more likely to see strong moves attracting significant follow though momentum.

The market will generally move into a new range of trading following this move. This will often signal the starting point for a new trend. This is another reason as to why this approach is important to take note of.

This method is flexible and can be used on any currency pair in conjunction with any chart time frame, from 5 minutes through to even daily or weekly charts.

How To Trade

Knowing how to use a breakout trading strategy to profit is a skill. On the surface it offers a relatively simple strategy which can be easily mastered. You buy the market when it moves beyond an identified resistance level and sell the market when it moves through a prior support level.

However nothing is quite so simple in practice. Markets don’t always move as expected. If you want to give yourself the best chance of implementing this strategy then you should look to observe some basic rules. These will help to ensure that you back only the strongest moves and will ensure you exit your positions quickly if the expected follow through momentum does not occur.

Here are some common rules that are particularly applicable to the breakout trader.

  • Trade at the best market times to give yourself the chance to capture strong moves
  • You can plan your trade before it happens, including setting our take profit and stop levels.
  • Also be sure to check for upcoming market news releases and data that may scupper an otherwise good trading opportunity.
  • Set a good risk versus reward. Keep your stops tight and don’t exit the move too early
  • Don’t enter the market too early. Wait for confirmation of the price action before opening orders.
  • Place a tight stop loss on your orders. If the move doesn’t follow through (which on some occasions it won’t) you need to exit with the minimum loss in order to maximize profitability

Breakout Trading Strategy Example

The following example shows the GBP/USD at the opening of the London markets. Here the overnight price action of the currency pair over the course of the Asian session is used to specify the range of interest. The highest and lowest points that are reached over this period are used as levels where a break is anticipated to occur.

Forex breakout trading strategy example

A ‘long’ order is placed to be triggered if the price moves beyond the top of this range and a staggered set of price targets are set to capture the follow through move. At this point momentum is anticipated to increase as traders jump on board the new market momentum.A tight stop loss level is placed just below the bottom of the lower level of the range.

It is important to note that the trade entry level is set a little beyond the actual range top. This is done so that the orders are not triggered by false market move. This helps to confirm the move. For a similar reason the stop orders are placed only a small distance from the entry level. This helps to ensure that the trade is exited quickly if the initial move subsequently reverses.

False Breakout Trade Example

Here we look at a false breakout trade using the same criteria for entry as in the previous example. Again we use the GBP/USD and the overnight range as the potential breakout levels.

false breakout trading strategy example

 

The term ‘false breakout’ is used to describe a trading setup where initially the move looks like a conventional break in the market will occur. However instead, the market initially ‘breaks’ in the opposite direction before quickly reversing and heading in the original direction. This can occur when the price is pushed to take out established stop levels before continuing its originally anticipated move.

To take advantage of this move orders are placed to be triggered in the opposite direction of the expected break. A price target is set inside the range and a stop level above the order entry level.

Ultimately as with any strategy, there are times when it will work more readily than others. Market conditions can change making particular approaches more suited to the prevailing price action. However the risk reward that is on offer from the breakout trading strategy makes it one of the more attractive trading approaches that you can implement. This also helps to ensure that holds up well throughout a wide range of different market conditions.