By: terry Allen
When Forex beginners first attempt a breakout strategy, they quite often become quickly demoralized. This is because their trades are frequently stopped-out just after activation. They are even more disconcerted when they watch the market price oscillate for brief time before proceeding in its original direction.
If, however, the price re-enters its previous consolidation pattern, then possibilities exist that the reversal could develop into a full-blown fakeout. To trade such a development requires careful pre-planning. A fakeout can be defined as a breakout that retracts back into the old consolidation pattern. They are serious threats to content with because they are created from about 20% of all breakouts on average.
Although these complications exist, you need to still understand that breakout trading offers excellent risk-to-reward ratios. This is because once the market price settles into a consolidation pattern, a breakout is capable of providing the energy sufficient enough to produce a very violent and extended move.
In order to successfully trade breakouts, you must make a maximum effort to distinguish them from fakeouts. In fact, fakeouts are generated so frequently that some traders have even developed fakeout trading strategies to enhance their profitability. So, is it possible for traders to detect real breakouts from fakeouts? Patience could be the answer here as will now be shown.
On a bull breakout the former resistance becomes the new support. Usually in the case of a real breakout, price will eventually retract touching the new support before proceeding in its original direction. The danger is, of course, is if price breaks below the support, then a fakeout could be formed.
As such, the best course of action would be not to open a trade immediately a breakout occurs but wait to see the closing price position at the end of the current trading interval. You are well advised to use the longer time periods when performing this task, i.e. hourly or the four hourly, in order to provide yourself with sufficiently accurate statistics.
If this course of action reveals that not only did the price breakout but also found support, then you will know that the probabilities are in favor of a true breakout. In the case of a fakeout, you would observe the price closing within the original consolidation pattern.
By simply taking advantage about the fact that the former resistance often becomes support after a bull breakout (opposite for a bear one), could provide you with an important technique for distinguishing breakouts from fakeouts.
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