Are you trading a breakout level? If so, then you know that a good breakout trade can generate significant profits. However, trading breakouts can often turn out to be unprofitable. For instance, you might see the price break through a resistance level on large bullish candles and, without hesitation, open a long trade. Yet, after some time, the price makes a sudden 180-degree turn, leaving you in the red. This leads to the question: "Which breakout trades will succeed and which won't, and is it possible to determine this in advance?"
What is a Level Breakout?
When trading, you need to use every possible advantage in your favor. Forget about trying to be right 100% of the time; this is simply
impossible. If you trade with a good risk/reward ratio, you can be right on less than half of your trades and still make a nice profit. You
must know how to find a good trading opportunity and be prepared to execute your trading plan.
In today’s article, I will try to answer this question and discuss everything related to breakout trading.
A breakout occurs when the price breaks through a certain level and continues moving in the direction of the breakout. For beginners, understanding this can be challenging, but it’s straightforward: consolidation is the closing of a candle behind a level. A breakout can occur at both horizontal and inclined levels. Breakouts often lead to increased market volatility. By waiting for a key level to be broken, traders can leverage this volatility to their advantage and join a new trend at its inception.
Why Do Level Breakouts Work?
Imagine a scenario with a strong resistance level on the chart, guarded by many bears, preventing the price from breaking through. After several unsuccessful attempts, the bulls receive reinforcement and break through the resistance. What’s next? They push forward to the next resistance level, where the cycle repeats.
Breakouts occur when the price surpasses a significant level. When analyzing price movements on a chart, you’ll notice that prices tend to
move in consolidations and meet certain levels. When the price reaches a level and quickly reverses, it signals the strength of that level.
Upon retesting this level, closely monitoring price movement is essential to anticipate a potential breakout.
Repeated attempts at the same level can indicate a strong level. However, price will eventually break through any level at some point.
That’s when traders should be ready to open a breakout trade.
Breakouts can provide excellent trading opportunities because they often lead to new price movements and trends, allowing traders to enter potential emerging trends early. Additionally, reliable breakouts typically occur when price momentum is strong, and traders are trying to maximize their profits from rapid price movements.
Key Levels for Breakouts
Breakouts occur at important price levels, such as:
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- Support or resistance levels
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- Market highs or lows
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- Trend lines
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- Price channels
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- Moving averages
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- Chart patterns
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- Fibonacci levels
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- Round numbers
One reason breakouts can move prices quickly is that many market participants watch levels around potential breakouts. When some traders exploit a breakout, others must quickly cover their losing positions, creating sharp price movements after the breakout occurs.
How to Trade Breakouts Effectively
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1. Expect Prolonged Consolidation: It’s best to enter a trade on the third and subsequent price touches of the resistance level, as fewer sellers remain, making a breakout more likely.
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2. Analyze Price Approach: Pay attention to how the price approaches the level. If the candles are small and the price gradually moves towards the level, it’s more likely to be broken.
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3. Observe Price Behavior: If the price consolidates as it approaches the level, it may indicate that there are few sellers to push the price away decisively.
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4. Set Orders and Stop Losses: When the price approaches the level, place a stop order to buy. Once activated, set a stop loss behind the candle that broke out. Use a trailing stop technique to maximize profits as the trend develops after the breakout.
Breakout trading can be highly profitable if you manage to enter the market at the very beginning of a long-term trend. By understanding the dynamics of breakouts and employing strategic entry and exit techniques, you can improve your chances of success in breakout trading.