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How to trade Breakout Confirmations
his article is all about how to confirm a breakout when it happens in the financial markets. Breakouts occur all the time, but the same goes for the opposite: the fakeout. You need to know when the markets are experiencing a breakout, or when the markets are just faking a breakout (fakeout). If you trade in the direction of the price move thinking you are trading a breakout, but you end up trading the fakeout, the reverse move will cause you to lose money in the trade.
What is a breakout?
A breakout occurs when the price of an asset pushes out of a price range to the upside or downside. In reality, a move below the lower border of a price range is termed a “breakdown”. However, for the purpose of this article, we shall be referring to both situations as a breakout situation. So we can also define a breakout as a situation where price pushes below a support level and closes below it, or pushes above a resistance and closes above it. Such a price move usually sets the pace for prices to continue in the direction to which the breakout has occurred. In other words, a breakout is a price continuation signal.
Breakouts can occur in several situations. They are commonly seen in the following scenarios:
- Resolution of chart patterns, when price either reverses or continues the previous trend that entered the pattern.
- Break of horizontal ranges, which are usually defined as rectangular patterns.
- When price pushes out of a channel, which could be an ascending or descending channel.
- When price moves above or below support-resistance areas such as Fibonacci levels, pivot points, etc.
A breakout is usually a sign that there has been a shift in the supply-demand dynamics that exist around a particular price level. Usually if there is more selling interest in an asset, prices tend to go down and if the buying interest is more, prices tend to go up. Of great importance to breakout situations is not really the buying or selling volume at any time, but the volume of hitherto uncommitted traders who join trades in a particular direction once the breakout has occurred.
Where to trade breakout confirmations?
Breakout confirmations can be traded with any Forex or CFD broker featuring forex trading on its platform. It is recommended to use a broker with the tightest spreads so you could give yourself a good chance to trade breakout confirmations successfully. In Europe, one of the best choices for forex trading is IQ Option, they operate on global scale with a few exceptions where they are banned, here is a list in what is countries IQ Option available, you are going to find there also the trading conditions that they have for specifics countries like the UK, Germany, Brazil, Mexico and many others.
Once you know where you are going to trade breakout confirmations, you also have to know how a breakout can be confirmed.
Breakout Confirmation Principles
There are two filters which are used to confirm breakouts. These are the time filter and the price filter.
- Price Filters
The price filter aims to use the position of the closing price of the bar or candle that has violated the support or resistance barrier, relative to the price represented by these barriers. Typically, a closing price penetration of 1% or 3% price is used as the price filter. What does this mean? It means that the breakout candle or bar must extends above the resistance or below the support and close at a price such that the distance between the closing price and the support/resistance lines is at least 1% (for shorter time frames) or 3% (for longer time frames) of the price at the support or resistance line.
This snapshot illustrates this:
Snapshot Showing Breakout (Price Filter Confirmation)
Here, we see that support is at 6028.77. The breakout candle closed at 5508.51. To determine the breakout using the price filter. The distance between the closing price of the breakout candle and the support price, must be at least 3% of the length of the breakout candle.
So 6028.77 - 5508.51 = 520.26
Next step is to divide this resultant number by the support price, and multiply the outcome by 100 to get the % penetration.
So (520.6 ÷ 6028.77) X 100 = 8.635%.
Therefore, the breakout candle fulfilled the penetration % required for the price confirmation of the break of support. As you can see on the chart, the price just kept going downhill from there, forming lower highs and lower lows.
- Time Filters
The time filter confirmation method uses what is known as the 2-day rule. The 2-day rule is simple: two successive candles must close above a resistance or below a support, irrespective of the degree of penetration. That’s it. You just need to see two candles forming in a row and closing above the resistance or below the support line for confirmation.
The snapshot below captures a breakout when the 2-day rule was fulfilled, and two scenarios where this rule was not fulfilled. In both instances where the rule was not fulfilled, the breakout of price above resistance and the breakdown of the support area both failed. This underscores the importance of using the appropriate confirmations and not just jumping into the market trying to trade a breakout.
Breakout and Fakeouts Filtering Using the 2-day Rule
Conclusion on how to trade Breakout Confirmations
In conclusion, you would have to test the two method to see which works for you. Complaints about the price filter usually border on price having gone too far into the breakout move, which is where the time filter may have some advantage, especially if there is a return move that is arrested by the role-reversed price level. There are also those who criticize the 2-day rule, saying that it could cause delays in entry if there is no pullback, leading to late entries.
Test both methods to see which works for you: both are effective in confirming the breakout moves and weeding out the fakeouts.
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