Breakout trading is used by forex day traders to capture the market move in its early stages. It can offer good starting point to enter the trend in progress, or get in just at its beginning. When executed correctly, it can produce positions with limited risk and great possible reward (positive risk reward ratio). Furthermore, breakout trading is market neutral. There is no effort to predict market moves. Breakout trader simply reacts and takes advantages of current market situation.
Breakouts in forex
Breakout occurs when price moves(breaks) above resistance or below support. This is typically accompanied by increase in volume on breakout candle. The more significant the S/R, the bigger move can be expected on breakout. In algorithmic trading, S/R zones are often defined by indicators such as envelopes or bollinger bands.
We can also consider various patterns occurring in our timeframe. It is necessary to consider them in confluence with major trend or massive S/R on higher timeframes.
We can identify tunnel in multiple ways. The most common is to look for clear trading range. Trading range can be either horizontal, or sloping. More advanced scenarios include various combinations of chart formations such as pennants and triangles. We always look for support/resistance (significant price levels) to be penetrated.
Algorithmic , trading ranges (tunnels) are often identified by two major indicators: Envelopes and bollinger bands. Both offer good degree of accuracy when identifying a breakouts.(MT4 Breakout Expert advisors)
Once we identify possible breakout zone we observe the price approaching it. Price closing in to the S/R on increasing volume confirms the signal (not mandatory).
To confirm the breakout we wait for strong bullish/bearish candle to close outside of tunnel boundaries.
Properties of valid breakout candle
Valid breakout candle must clearly close outside of our S/R tunnel. It must be strong bullish/bearish candle. Wick closing in the direction of breakout must be narrow. Wick wider than candle body may signalize fake out and it is better to be avoided. Finally. Breakout candle is confirmed by increased volumes activity, compared to few previous candles.
Closing the breakout trade
Upon entering the breakout trade stop loss is placed at opposite (unbroken) side of the tunnel. Take profit is placed in the distance that equals tunnel width (at breakout point). This is the most widely used and conservative method.
Advanced methods for breakout trading
The standard advanced method: Once the initial breakout fails (fakeout), we enter the trade into opposite direction with increased leverage (2x). Winning second trade will cover for previous loss and add profit. This can be repeated multiple times if necessary.
Aggressive pyramiding method:
Rapidly moving price after the breakout can be pyramided. As the price moves in our breakout direction, we can add multiple positions to our winning trade. Sometimes it is possible to add up to 20 positions to our initial order. This methods tremendously increases possible rewards while keeping the risk as low as with first entry. This complex method can be traded by News and breakouts MT4 expert advisor by theforexkings.