Secrets of Forex Breakout Trading Finally Revealed
Every trader knows the Forex market spends most of the time in consolidation. This simple statement makes everyone looking for a perfect Forex breakout strategy. Breakout trading allows great risk-reward ratios. Because of this, Forex breakout trading strategies are popular among traders.
What drives people to Forex trading is the ability to make money. Quick and fast. In theory, this is true. But, the reality looks different.
While the trade may take a little time, the preparation takes a lot of work. It is like going fishing. Like fishermen, traders wait for the right opportunity, patiently, and they keep trying until the perfect setup appears.
All trading platforms offer at least one breakout Forex indicator. You may not recognize them by their name, but there are plenty of them.
Famous trading strategies look for breakouts, too. Think of the Elliott Waves Theory. To trade a Forex breakout system with it, traders wait for the consolidation to end.
This is either the 2nd or the 4th wave in an impulsive wave, or the a-b-c correction of a cycle, and so on. The moment the correction ends, breakout trading for the impulsive wave starts.
Technical traders love breakout trading systems. In fact, such strategies appeal effectively to these traders.
When trading economic news, breakout trading mostly ends in fake moves. The Forex market is well-known for the large, fake swings currencies make.
Such swings are the result of high-frequency trading. Super-computers buy and sell thousands of positions every second for a small profit. Hence, the market makes huge swings with little or no reason.
Trading breakouts appeals to retail traders. Because of that, either beginner or an experienced trader, this article shows you how to make a buck in the Forex world using the best breakout trading strategies.
The Best Forex Breakout Trading Strategies That Work
Like any things, in life, keeping it simple works best. Only because a trading platform offers tens or hundreds of indicators, you should not use them all.
Trend indicators, oscillators, momentum indicators…all show the same thing. Sure, they’re here to help, but if they are so accurate, everyone would make money. Which, as we all know, is not true.
Using multiple indicators on the same chart is a vital mistake. Professional traders try to avoid this as much as possible.
Take, for example, oscillators. They all show the same thing: overbought or oversold conditions. Why use more than one then?
Of course, different strategies work with different indicators. But, looking at too many ends up being a waste of time.
Try to filter the indicators used. The best way to do that is to think of you as a person.
This may sound silly, but everything starts with you. You are the trader, you take the decisions, so make sure you know yourself before committing to trading.
Know your capabilities and flaws beforehand. In doing that, adjust your strategies and use the ones that fit you as a person. Or, that fit your lifestyle.
Be honest with yourself and explore the trading possibilities you have. Let me give you an example.
Let’s assume you just discovered an amazing intraday breakout trading strategy. Or, as a matter of fact, a trading system that makes money. For real!
However, when back-testing it to see how it performed in the past, you end up seeing that you cannot trade the signals. How come?
Various reasons can cause this. If you have a job, you’ll miss most of them. Or, they may appear mostly in the European and the New York session, while you live in Asia. And so on.
Long story short, having a trading breakout strategy that works, might simply not work for you. Another reason would be that the strategy gives only a few signals per week.
However, you’re an impatient person and want some more. With this attitude, you’ll end up blowing your trading account.
Preparation, patience, and discipline are key in successful trading. As such, start from knowing what you can bring to the trading table, and build from there.
In doing that, you can pick the time frame that suits your lifestyle and personality. And, you can choose a breakout trading style that suits you best. Moreover, you can make your own breakout trading rules.
Here are some of the most powerful trading breakout setups technical analysis offers. Again, simple things work best. Master them, and you’ll master the market.
Forex Breakout Trading Around Psychological Numbers
Psychological numbers always fascinated technical traders. Multiple Forex breakout systems were developed around these levels.
In the Forex market, these represent round numbers. To give you an example, the parity level on any currency pair is a ground-breaking level.
Or, levels like 1.10, 1.50, 2, and so on. Volatility increases around them, the trading volume gets bigger, etc.
Trading breakouts around these levels pays. Below is the USDJPY four-hour chart. After Bank of Japan decided a few years ago to embark on a huge quantitative easing program to fight the lack of inflation, the JPY sold aggressively.
So powerful was the move, that the market barely corrected from the 80 area all the way to the critical 100 level. And then it failed at it.
The first attempt saw buyers pushing all the way up until 99.94. Price collapsed from there to 95.50. Think of it for a second: does price travel so big a distance without reaching the round number?
Bulls pulled another breakout Forex strategy for the level and pushed again. The second attempt failed at 99.88. Still not enough, as bears responded with a 97 move.
Triangles represent great Forex breakout patterns. Price simply takes its time, building energy to break.
The same here. It even formed a bullish flag at the end of it. How to trade this? Wait for the upper trend line to break. Or, place a pending buy stop order at the round number (100 level) and target the same distance as the longest dip in the triangle.
When trading breakouts, Forex traders must wait for the perfect setup. This is a perfect example.
Volatility Breakout Trading
The Bollinger Bands indicator is one of the best indicators for volatility breakout trading strategies. However, many use it in the wrong way.
Volatility breakout trading with this indicator focuses on the distance between the UBB and LBB. These are the upper and lower Bollinger Bands.
As a rule of thumb, the smaller the distance between them is, the more powerful the Forex breakout will be. Hence, traders can adapt the breakout trading.
Below is the EURUSD four-hour time frame. It has the Bollinger Bands indicator with the default settings on it.
Here is a short guide for such a breakout trading method. One can use it on any currency pair.
First, look for a Forex breakout on the currency pair. This means, effectively measure the smallest distance between the UBB and LBB, before a breakout.
Second, use it as a reference for future breakout trading. The two blue lines represent the measured move before a breakout.
If you use them for back-testing, you’ll see that every time the gap between the two narrows, the price will break. However, such an approach many false breakout trading signals.
Yet, this breakout Forex system still works if implemented with money management rules. One way is to use a stop loss at the previous swing after the breakout and a 1:3 risk-reward ratio.
As such, you’ll filter fake signals. Moreover, a breakout Forex strategy that uses great risk-reward ratios has more chances to survive the test of time.
And, it makes you a better trader. It keeps emotions well under control, and discipline reigns.
The Bollinger Bands is a great Forex breakout trading indicator mt4 platform offers too. In fact, all trading platforms offer it. The key is to know how to use it properly.
Using a Trendline Breakout Trading System
A trendline is the line of a trend. As such, when the trendline gets broken, the trend falters. This makes trendlines great tools in a Forex breakout analysis.
To draw a trendline, one needs two points. By connecting them, and projecting the outcome, you’ll have a trendline.
In any breakout trading strategy Forex traders use, the break of a trendline is a big deal. Moreover, the bigger the time frame is, the more important the implications.
However, false breakout trading is the norm here too. Therefore, traders must know what to do in case the trendline experiences a false break.
Support and resistance breakout trading looks like in the chart above. Let me explain it in a few words.
This is the USDCAD daily timeframe. Quite a big timeframe, so the implications here will end up moving the Forex dashboard.
The first rising trendline experience a fake Forex breakout trading signal. Why is that?
Well, the trendline broke. However, there was little or no follow through. Moreover, price reversed and made a new high.
This new high is the signal to move the previous trendline and create a new one. The new trendline is part of a new trendline breakout trading strategy.
As it happens, the market broke this one too. This is bearish. Again, money management comes to save the day.
This breakout trading strategy holds true if the previous highs hold. As such, that is the invalidation level or the stop loss.
A 1:3 risk-reward ratio will do the trick here too. Simply measure the distance from the trendline to the previous highs. That is the risk.
Multiply it by three, and project it from the Forex breakout level.
Finally, adjust the volume of your trade to the time frame. That’s a great Forex breakout indicator.
And now, let me show you a video example of what I mean. I conducted a trade that shows a valid trend breakout, which made me go short at the EUR/USD Forex pair. Just enter your details and you will be able to see the trading example for FREE!
Notice that the breakout came as a result of the price interacting with the upper level of another pattern. This gave an extra confirmation of my signal and I traded to the opposite level of the purple pattern.
Channel Breakout Trading Strategy
Channeling is a great technical analysis feature. Even corrective waves in complex theories, like Elliott Waves, channel.
Furthermore, in breakout trading, Forex traders love to use visible patterns. Channels have this feature.
A Forex breakout from a channel is a strong signal. In a bullish channel, traders should sell. In a bearish one, they should buy.
But, there’s a catch. Wait for a retest of the channel. Breakout trading without the channel being retested generates fake signals. Hence, avoid it!
In breakout Forex trading, the time frame plays an important role. As usual, the bigger the time frame, the more important the Forex breakout is.
The USDJPY weekly chart above shows an impressive bullish channel. In fact, this is the rising channel after Bank of Japan engaged in unconventional measures for its monetary policy.
It took years for the channel to break. But when it did, the trading breakout strategy worked like a charm.
The next two weeks after the break brought the much-expected channel retest. There’s no clearer entry than this one.
Of all the trading breakouts Forex pairs make, the ones on the bigger time frames matter the most. In Forex breakout trading, confirmation is key.
Even here, the same money management rules give a disciplined approach. Stop at the highs and targeting a 1:3 risk-reward ratios worked like a charm.
What’s interesting here is that everyone was bullish then. Fundamentals called for further upside. Yet, the technical analysis offered the true direction.
With such a breakout strategy, Forex traders have a disciplined approach for all pairs. And timeframes too. Simply wait for a channel to break, look for its retest, and trade in the direction of that break.
Remember? Simple things work best!
Intraday Breakout Trading Strategy
This article stated that the Forex markets consolidate most of the time. If that is true, how do we know when the range ends? When does the breakout trading begin?
One way to solve this riddle is to use pivots. They are great breakout trading indicators.
For such a breakout strategy, Forex traders use the classical pivots or custom-made ones (Camarilla pivots, etc.). However, trading a Forex breakout is the same.
The EURUSD four-hour chart above shows the pivots indicator. A Forex breakout trading analysis based on pivots shows the same levels on all time frames.
The idea is to look for a Forex breakout, right? The actual pivot represents the balance.
Everything above is resistance, and everything below is support. Such a breakout trading setup bodes very well with retail traders.
How come? It suits scalpers.
Because markets consolidate most of the time, look for either R1 or S1 to come first. In this case, the EURUSD moved to the S1 level.
This still shows a range. If the price stays between S1 and R1, no breakout trading occurs. If anything, buying S1 with a stop at S3 and a take profit at R1 works best.
Wise traders use the time to their advantage. They wait for economic releases to hit the wires.
Next, the daily fixing time. After these are left behind and the market still ranges, chances are it will move back to the pivot.
Therefore, even though traders look at pivots for a Forex breakout trading, they end up trading a range. This is normal as a Forex breakout doesn’t happen that often.
This simple trading strategy showed here has amazing results. This is just one currency pair, but imagine you use it on others too. If you do that, make sure you avoid correlated pairs.
Breakout trading systems represent the bread and butter for retail traders. Online retail traders scalp most of the times.
Scalping means they look for quick and fast moves the market makes. Therefore, they look for a Forex breakout to happen.
Because the bigger timeframes range most of the time, traders must go to the lower ones. Fifteen-minute, five-minute and even one-minute chart can be part of Forex breakout trading.
But, this comes with additional costs. Trading more doesn’t mean more profitable.
Traders end up making the broker happy. They’ll pay more in commissions. Furthermore, breakout trading on lower timeframes takes a lot of time.
Traders end up in front of the trading screens for most of the trading day. Not that this is a bad thing, but in the long run, it ends up being a costly mistake.
Therefore, a recommended Forex breakout trading should start from the hourly chart and above. One doesn’t have to be in front of the screens for the whole day.
As indicated at the start of this article, the breakout trading approaches shown here work best in any trading environment. However, only if money management conditions and rules follow.
But any trader knows that money management is as important as the actual trading system. Sometimes, only the money management rules make a system profitable or not.
All in all, Forex breakout trading is the reason why retail traders buy or sell currencies. However, they do that on the lower timeframes.
Investors, or professional traders, look at the bigger picture and act accordingly. As such, they end up trading a real Forex breakout right when retail traders exit a break on a lower timeframe.
What is breakout trading then? Nothing but a disciplined approach that works best on bigger timeframes.
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Damyan is a fresh MSc International Management from the International University of Monaco. During his bachelor and master programs, Damyan has been working in the area of financial markets as a Market Analyst and Forex Writer. He is the author of thousands of educational and analytical articles for traders. When being in bachelor school, he represented his university in the National Forex Trading Competition for students in Bulgaria and got the first place among 500 other traders. He was awarded a cup and a certificate at an official ceremony in his university.