By: Terry Allen
As explained in previous articles, if you are patient and simply wait for the initial breakout move to unfold then this course of action may help you avoid fakeouts which have the major characteristic of settling back inside the original consolidation pattern.
Some forex trading patterns are notorious for producing fakeouts. Head and Shoulders is one of them which as a pattern consisting of three rally points. The middle one is the highest (head) supported by the smaller left and right ones that form the shoulders. The pattern appears similar to the head and shoulders of a human.
Head and shoulders are located normally in the middle or at the end of an uptrend. Similarly, inverted head and shoulders are formed in the middle or end of a downtrend. When a head and shoulders pattern is found at the end of an uptrend, it signals either a bearish reversal or a consolidation period before the uptrend is continued. As Head and shoulder patterns are notorious for precipitating false breakouts, they are best avoided by traders, especially novices.
Other very misleading but popular patterns are the Double Top and Double Bottom. A Double Top consists of two rally points separated by a valley although the two peaks do not need to be of the same height. The double bottom is the inverse. Many new traders use these formations as signals for possible breakouts. However, fakeouts are frequently produced by the market at such times because it has simply run out of steam and is no longer capable of achieving higher highs or lower lows. Major reversals can then occur as a result.
Many traders particularly like to trade breakouts whenever resistance or support levels are breached. This is because many independent traders logically assume that, if a support or resistance level is penetrated, then the price action should have sufficient momentum to continue its move in the direction of the breakout. As a result, there is a tendency for a large number of entry stop orders placed above resistance levels and just below support levels.
In summary, you cannot just stop planning when you have determined a breakout entry point. Instead, you must deploy forex techniques such as money management, technical and stop loss analysis in order to provide yourself with the best protection against the negative effects of fakeouts.
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