Learn To Trade the Breakout (Part I)
Written by Ahmad Hassam on August 6th, 2009
A breakout typically occurs when the currency price moves beyond the period of consolidation or range trading. Who doesnt want to reap massive profits from a big price move in a short time? This is what breakout trading can provide you.
A breakout occurs when the price moves above or below a support or resistance level whether temporarily or permanently. There are times when trading the breakout can be very profitable even though breakouts are known to be technically unstable.
You will have to take into account many market factors including both the technical and the fundamental analysis in order to trade breakouts with a higher probability of success.
Both stocks and futures are traded on a centralized exchange. At the end of the day the traders can find out the volume of each security that had been traded during the day. The volume information is easily available for stocks and futures. Information about volume is critical to trading the breakout.
However, volume data is not available for currency markets due to its Over the Counter nature. This data cannot be collected due to the decentralized nature of the currency markets. Volume reveals where the market is positioned or positioning. Lack of forex volume data is a huge disadvantage to forex traders.
Successful breakouts are generally accompanied by a rise in volume. Volume is a very important criterion for any breakout trading strategy. It signals a change in the underlying supply and demand conditions possibly triggered by a change in market sentiments caused by some new markets fundamentals when the price attempts a breakout of a significant support or resistance level.
Successful breakouts must be accompanied with a strong surge of momentum in the direction of the breakout. Price breakouts can be of two types: 1) Continuation Breakouts and 2) Reversal Breakouts.
Continuation Breakout: In a continuation breakout, the price action climbs higher in continuation of an uptrend or falls further lower in a downtrend. Currency prices break out of an established price level to again resume the underlying trend. The breakout occurs after a period of consolidation. The buyers and sellers of the currency pair try to regroup and think about the next price move.
Reversal Breakout: Sometimes a breakout my lead to a trend reversal and the beginning of a new trend in the opposite direction.
There are many times when the price action does not move in a straightforward direction in the markets. A false breakout may occur. The prices may break the support or resistance but then retreat back into the previous price zone.
Stopping out most of the breakout traders if they have placed their stops just above or below the resistance or support levels! The worst kind of a breakout is the whipsaw type.
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