Lesson 10.5 – Breakouts
Breakouts to a technical trader mean exceptional trading opportunities, primarily because it signals that the exchange rate has broken out of its normal trading range.
To be considered confirmed, breakouts generally need to occur with an accompanying increase in volume.
Breaking Support and Resistance
Identifying support and resistance levels makes up the first step in recognizing breakouts. Typically, the extreme points at which the currency pair has reversed over a relatively recent period of time make up these levels that represent where buying interest overwhelms selling interest and vice versa.
A breach of an important support level with an accompanying increase in volume and generally lower exchange rates will indicate a breakout to the downside.
Conversely, a penetration above a key resistance level to make a new high on a rise in volume would indicate a breakout to the upside.
False Breakouts
Not all breakouts follow through and continue in the direction of the breakout. Often, false breakouts will occur which can result in losses for the trader that fails to identify them as such before taking a position.
One way that false breakouts can be avoided is to wait for a confirmation that the breakout is real. A confirmation of a breakout need only consist of a higher consecutive close, an increase in trading volume or some other positive confirmation such as the rate maintaining above or below a certain level.
Many experienced traders will not trade a breakout without some form of additional confirmation from the market.
Trading Breakouts
Trading a breakout could be considered a high percentage trade, in that the likelihood of a trade being profitable seems rather high. Nevertheless, this applies only to correctly identified breakouts, and unfortunately, many breakouts turn out to be false.
Also, when trading breakouts, you will usually want to make sure that your stop-loss is placed immediately above resistance or below support for added protection.
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