Xkyxword Training Program 1

Prevented False Breakouts

How to Prevented False Breakouts?

Breakout trading has become popular as traders await many pairs to breakout from their
consolidating ranges. Trading a breakout strategy is fairly straight forward; traders will look to
buy a breakout of price above resistance or sell as price breaks through support. However, there
is one question on the back of everyone’s mind. How can I avoid false breakouts?

A false breakout occurs when prices moves through a support or resistance level and proceeds to
immediately move in the opposing direction. Below we can see a false breakout on the EURUSD
pair. Support was consolidating throughout early trading as denoted by a series of higher lows.
Price moved through support perhaps triggering fresh short positions, but quickly moved higher!
Surely there must have been a warning signs about price retracing after breaking support.

Many traders think that indicators are the answer. Unfortunately, every indicator we have
available to us is lagging in nature. Whether it is a classic oscillator, moving averages, channels,
they all rely on an interpretation of past price action in an attempt to find price direction. This
 Xkyxword Training Program 2
Prevented False Breakouts

leaves us at a loss as a breakout trader, because more often than not price will move against us
faster than an indicator can update.

One aspect that we can control as traders is risk management. We need to decide how many
pips we are ultimately willing to accept in loss, for an attempt to make a profit. Below, we can
see a daily chart of the USDCAD. The Range has been broken at present and many breakout
traders are opting to enter fresh sell positions under .9850.

Risk has been divided into two portions equaling half the distance of our range. Aggressive
traders may choose to set stops in Risk Zone 1. In the event of price retracement, traders utilizing
this zone will exit the market quickly. While minimizing our risk to the smallest levels possible
is definitely a plus, it should be expected for trades to be closed out fairly quickly. This may
eliminate giving your trade space to return back in the direction of your trade.

Conservative traders may choose to set stops in Risk Zone 2. Risking up to 100 pips to .9950 on
the USDCAD gives the trade ample room to run. If price breaks through resistance, our trade is
 Xkyxword Training Program 3
Prevented False Breakouts

not immediately in jeopardy of being closed. However, having a wide stop comes at a cost. If our
trade continues to move against us, we ultimately may risk twice as many pips in loss than a
trader choosing Zone 1.

RISK Paradigm

Aggressive Stops More Stop outs Less Pip Risk

Conservative Stops Less Stop outs More Pip Risk

As a trader we need to find which category we fall into, using the Risk Paradigm above. Once we
have decided on a course of action regarding risk, we can ultimately ignore the false breakouts
we were so concerned about before. By focusing on these conditions we can control, we can
ultimately plan our breakout trades more effectively and be better prepared for any market move.