Forex Trend Breakout - Methods to Spot a Coming Breakout
Updated: April 12, 2013 at 7:47 AM
Support and resistance is a well-known concept in forex and other types of investment. The concept arose from the observation that prices sometimes "test" a certain limit multiple times. For instance, a security might reach $37 repeatedly before falling back down again and again. The same can happen as a price falls - this time bouncing up repeatedly from a level of support. This happens with enough of a pattern to be statistically significant. In this article we'll talk about breakouts, how you can spot them and how you can profit from them.
The value of breakouts
Such a pattern is useful enough to be traded on, but there is another phenomenon that makes it even more profitable. If the market keeps on pushing the price up to the resistance point, it will probably break through eventually. This is where things become especially interesting, because such "breakouts" seem to turn all of the resistance or support they pushed against in an opposite direction. Suddenly, there will be a quick spike that is far more rapid than the previous movement. (Downward trends that continue through support levels are called "breakdowns.")
Why is it important to spot a breakout before it happens?
The strength and speed of a forex trend breakout is why it is so important to predict it. If you are unprepared, the quick jump in value will be over before you ever had a chance to profit. So how can you predict breakout and distinguish it from just another test against resistance/support?
The first question is surprisingly simple: why do you need to? Of course, you need to be in the market before the breakout begins, but this is where you should have already noticed a pattern. If a currency repeatedly works towards a resistance or support point before bouncing back, you should already be taking advantage of it. This is why it's crucial to notice trends and stay on top of them, sometimes they develop into much more. It's also why it's very good to set your sell orders slightly below the resistance point. For instance, if a pair repeatedly climbs 10 pips before bouncing back down, wait to sell, or set your sell order 1 pip below the resistance with the condition that the price must reverse before selling. If it bounces again, you'll still profit well, but if it breaks through, you can also benefit even more.
How do you spot a breakout in advance?
However, that doesn't actually answer the question. How do you spot a breakout before it happens? The answer is more technical than the confines of a short article can permit, but you should rely on technical momentum indicators such as RSI, ADX, and stochastic analysis. If you know how to work with these tools, take advantage of them; if not, learn how and incorporate it into your strategy. None of these methods is absolute, but they are the best that can be done. The strongest results come from multiple, overlapping indications, such as when 2-3 of these technical indicators agree. Remember, that if you could predict breakouts or any other market event with near certainty, you would be able to trade profitably for however long you could keep it up.
Another important, but undervalued tool in this respect is volume. As you evaluate repeated testing trends, note the volume for each. When a new trend begins, expect to see much higher volatility if it will break through. By this time, you should be in the market anyway, benefiting from the basic trend if not more. However, either way, you will be prepared to profit and make the most of the opportunity.
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.