A breakout occurs when the market price moves beyond a prior identified trading level. This could be a level of support or resistance, a move outside of a technical reading or a breakout from an overnight trading range for example. Whatever the trigger, the breakout is the point that price action pieces this level and the price surges into a new trading range.
For a breakout to be successful it must be accompanied by increased volume. This is an important as without increased volume, it is unlikely that sufficient momentum will exist and the breakout will fail. The term false breakout is used for times when the initial break occurs, but insufficient momentum is behind the move for the price to maintain beyond the breach level.
So why do we assert that breakouts could prove to be the ultimate strategy for Forex? Well, perhaps one of the most obvious reasons is that they have the potential to yield high gains. The strength behind a breakout can give a huge potential for pips to be booked. The speed and vigor with which a strong breakout can move can be one of the most profitable ways in which to build an account.
There are however a number of other benefits to trading breakouts. These make this approach to trading beneficial for both new and more experienced traders.
One of the key benefits to trading breakouts is that they allow you to plan your trading in advance. You can analyze your charts to identify key levels where a breakout in price may occur. This will help you to shut out the noise from the markets and plan your trading. This will also give you plenty of time to check across timeframes and cross reference fundamental factors which may affect any potential trade.
The advantage of this approach is that it helps to install good discipline. Planning and preparing your trading will go some way to preventing rash decisions at the point of trading. It will help to create a framework and add structure to your overall trading plan.
A benefit of being in a position to identify potential trading opportunities in advance is that you can also calculate the potential risk-to-reward on each outcome. This provides an important metric with which you can assess the performance merits of each potential trade.
Successful trading very much comes down to balancing risks. Once you identify the break point you intended to trade, you can also look to identify areas that the market may run to. At this point you may want to close your order. Similarly, you will also need to identify a position where you can place your stop. This is where you will exit the market if the expected breakout does not follow through and reverses.
In identifying your entry, take-profit, and exit points, you can calculate the risk/reward ratio on the trade. This will reveal if the risk makes the opportunity worth taking and ultimately will allow you to stack your trading in your favor.
By the way, you can use our free Chart Pattern Helper expert advisor to completely automate your breakout trading.
Once you have identified your breakout trading opportunities and are satisfied that the risk versus reward merits them being trading, all that is left is the execution.
At this point, the benefit you will receive is that you will have effectively removed emotion from the trading process. Instead at the point of trading, your function will simply be to execute the order in line with your prior analysis. There is no requirement to work out where you are going to exit or where you place your stops. This has all been calculated in advance and factored into your prior analysis of the trading opportunity.
This mechanical execution is vitally important as this is what most traders will struggle with. Trying to work out where to exit the market when an open position is moving against you will often see unacceptable losses pile up. Similarly failing to take profits on an open position will frequently see them evaporate.
The psychological aspects here are key and can have a profound effect on trading performance if not kept in check. This is why using a breakout strategy for Forex which is well defined in advance can prove to be the ultimate Forex strategy for a trader.
by Phil Moore
Phil Moore is a full time trader who has been running and mentoring traders in his London Forex Open strategy since 2009. You can find more information on his successful breakout trading strategy at LondonForexopen.com.