Most breakouts in forex actually fail, so it's important to be able to spot false breakouts and even take advantage of them. Here's how to do it.

In forex trading, there are many great strategies to use for various different situations, and every trader typically has specific preferences when it comes to their trading plan. One of the most popular trading strategies in forex trading is called trading breakouts. The "breakout" essentially occurs when the price "breaks" out of a key level, mostly support or resistance. You can expect the price to keep moving in the same direction as the break when this happens. So the idea of trading breakout is to enter the market when the price makes a breakout and continue riding the trend until volatility dies down.

Fakeout Strategy

However, one must understand that the forex market is mainly unpredictable, so forex trading is always risky regardless of how strong your strategy is or how skillful you are. While some traders might convince you that there is a perfect system that works 99% of the time, the reality is that anything can still happen.

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With that being said, the issue with the breakout trading strategy is that when a breakout occurs, there is no real guarantee that the price will always continue to move in the initial direction of the momentum. In fact, most breakouts in forex fail, so the price might suddenly move in the opposite direction after the breakout happens. Even if the trader is confident that they have done everything in the right way, the market can still betray them and move against their initial expectations.

Indeed, fake breakouts or fakeouts can be quite frustrating for traders because they can completely catch you off guard and often result in a losing trade. But did you know that even though false breakouts are mostly considered harmful, they can also be a great strategy on their own? Yes, it's very much possible to use false breakouts as a profitable trading setup, but only if you know how to use them.

 

How to Identify Potential Fakeouts in Forex Trading

Before we learn how to trade fakeouts in forex trading, it's essential to know where potential fakeouts might occur. If you don't know how to identify the fakeouts correctly, you won't be able to trade them profitably. For instance, you might misread the price action for a fakeout; the price could move back to the breakout level only to confirm the previous breakout and move in the direction of the initial breakout.

 

Check the Trading Volume

The first way to identify potential fakeouts is by looking at the trading volume. Actual breakouts are accompanied mainly by strong trading volume in the direction of the breakout. When there's no significant volume change, there's a higher chance that the breakout will fail. So if the trading volume is small or even decreasing during a breakout, then you might be looking at a fakeout. In contrast, the breakout is probably real if the trading volume is high or increasing rather significantly.

Identifying real breakout

We have added the Volume indicator at the bottom of the chart above. Notice that the indicator is showing a significant increase in trading volume at the time of the breakout. And afterward, the price continues to move in the direction of the break. This shows a correlation between trading volume and price breakout.

 

Price Action around Key Levels

Another crucial matter to keep an eye on is the support and resistance levels. False breakouts usually occur when the support and resistance levels are created either through trend lines, charting, or previous highs and lows.

By using a trend line, it's essential to make sure that fakeouts usually appear when there's a space between the trend line and the price. If you notice a gap between the trend line and the price, then it means that the price is moving away from the trend line and thus more likely to form a fakeout.

The speed of the price is also significant. If the price moves slowly towards the trend line, then a false breakout might occur. In contrast, if the market price moves incredibly fast towards the trendline, then you can expect a real breakout to happen.

 

Lastly, you should also take a good look at the breakout candle. This is even perhaps the most important and reliable determinant on the list. If you're looking for a real breakout, always make sure to wait until the breakout candlestick closes above the resistance zone or below the support level. But if the candlestick fails to do that, you're probably looking at an upcoming fakeout.

Resistance Zone

The chart above shows multiple false breakouts that happen inside the resistance zone. Coincidentally, the zone was also previously tested by several fakeouts. As the price was never able to close above the upper line of the resistance zone, the breakout attempts were never confirmed and the price moved back down under the resistance. It's probably safer to wait until the price opens below the lower resistance zone after a fakeout to open a sell position.

 

Identify the Chart Patterns

When it comes to chart patterns, there are two common ones where fakeouts tend to occur: head and shoulders and double top/bottom. The head and shoulders pattern is actually pretty hard to identify compared to other price patterns. Meanwhile, a double top/bottom pattern is pretty easier to spot.

 

How to Trade Fakeouts in Forex Trading

The key is to trade against the Dominant Trend:

  • In an uptrend, wait for pullbacks into support and a false breakout to form at this support level.
  • In a downtrend, wait for a retracement into resistance until a false breakout occurs at this resistance level.

Afterward, open order after the breakout candle closing price. It's actually a great idea to enter right after the breakout candle closing price because then you will have a tight stop loss and a higher potential profit. Remember that you can trade fakeouts based on support and resistance levels and also against other technical levels or price action patterns.

If you're in doubt, utilizing pending orders can be a great idea. If the price pulls back to a support level, you can place a buy stop order around the closing price of the breakout candle. On the other side, a sell stop order is recommended following a retracement from a fakeout that happens at a resistance.

 

Final Verdict

As a trader, it's highly crucial to understand that the forex market can be unpredictable at times and may not always move the way we predicted. To be fair, if trading were just as easy as most people claim it to be, then everybody would be millionaires by now. Even the best trading plan or the most expert trader can sometimes fail, so losing the trade is not very uncommon in forex trading. For this reason, you need to be able to save yourself when the market decides to turn against you and mess with your plan.

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Fakeout or false breakout strategy is one of the great examples of how to turn unfortunate events to your advantage. Instead of avoiding the fakeout, you can search for it and trade with it. Fakeouts can occur in all types of market conditions, whether it's trending, consolidation, or sideways. It can be a powerful signal to determine your entry and exit points.

The most important thing is to identify clear support and resistance levels and be able to hold your patience to wait for the market price to form a false breakout before entering the market. In addition, it would be much helpful if you had a basic understanding of technical analysis and technical trading tools. This would give you a considerable advantage over the average forex trader.