How to Use Technical Analysis to Trade Breakouts
Breakouts are one of the most commonly occurring phenomena in technical analysis-based forex trading. They are a result of price consolidation or congestion.
The consolidation or congestion periods can occur at any time: before a trend, within a trend or after a trend.
Trading breakouts is quite a popular short-term FX trading strategy. Breakouts are particularly popular with intraday traders. This is because breakouts occur regardless of the timeframe of the security in question.
A quick move following the breakout can yield good profits depending on how leveraged a forex trader is. While breakouts offer a great way to maximize profits, they aren’t that easy to master.
This is because breakouts are volatile. There is no guarantee that price will maintain the momentum following a breakout.
There are many approaches to trading breakouts using technical analysis. But before we get into that, let’s briefly look at the concept of breakouts in forex trading.
What Are Breakouts & Why Do They Happen?
Breakouts happen when price moves outside the defined range. This range can be identified by support and resistance levels. But it is not just the horizontal breakouts. There are many chart patterns that work on the concept of a breakout.
For example, the ascending or descending triangle patterns, and the bullish and bearish flag/pennant patterns are all different versions of depicting a breakout.
Higher volume is another way to qualify a breakout, evident in the case of stocks.
Breakouts happen as a result of an increased investor or trading activity. Breakouts are usually triggered due to fundamental drivers.
For example, you can notice price maintaining a consolidation or a ranging phase. This range is breached upon the release of a high impact economic indicator, or speech.
Breakouts are explosive because forex traders react to news that is not discounted already. The breakout is merely a response to repricing in the asset. This leads to a strong and explosive move in price. A breakout is a result of forex investors and traders adjusting to the newly released piece of information.
But sometimes, you might also see breakouts for no reason. Such breakouts are a result of technical forex trading and trader positioning. When there is a concentration of orders at a certain price area, it can lead to a strong breakout as a result.
Common Ways to Trade Breakouts Using Technical Analysis
We can primarily split breakout forex trading methods using technical analysis into two categories.
The chart patterns mentioned earlier, alongside other patterns such as head and shoulders, etc. draw upon the concept of a breakout. The main thing to focus here, of course, is past price history.
When you identify that price has been consolidating or failing to move past a certain price level, it can lead to a breakout.
Using oscillators such as the RSI, Stochastics and so on is another way. Most of these oscillators are based on momentum. Momentum is a great forex indicator that tells you how strong the breakout it. Typically, you will also see volatility rising during a breakout.
Forex traders usually draw upon one of the above or a combination of both to successfully trade breakouts. One should remember that there is no silver bullet that will consistently reward you with successful trades. Because of the irrationality of the forex markets, risk is also something that FX traders should consider.
But there is something that you can consider to qualify your breakout trades better.
- Momentum: Momentum is a great way to determine the longevity of a breakout. When momentum is high, there is a higher probability that price will continue moving in the direction of the breakout.
- Volatility: Volatility is a measure of the degree of variation over time for the price of the security. Looking at historical volatility can give you a rough estimate on the breakout target.
- Volume: A breakout can also be qualified based on the volume. Depending on the asset you are trading, volume can be a great indicator of whether the breakout can be sustainable.
- Risk/Reward: Last but not the least; the risk/reward ratio is also a factor to consider. It is essential to have the right risk/reward set up. This will determine the level of success and consistency in having profitable trades.