Being a trader requires everyone involved in trading activities to understand the various terms used in the trading world. One of the terms that will be heard often is “breakout”.
Breakouts in trading refer to situations where the value of an asset moves past an area of resistance or breaks through an existing support line.
Technical analysis utilizes breakouts as potential signals to identify trading or investment opportunities.
Check out the full review below to better understand what a breakout is, the term bounce in trading, its types, examples, and the best strategies.
What Does Breakout Mean?
Quoting investopedia.com, a breakout is when the price of an asset moves above an area of resistance or below an area of support. Breakouts indicate the potential for the price to start following the trend toward the breakout.
For example, an upward chart pattern breakout may indicate that the price will begin to follow an uptrend.
Breakouts with high volume (compared to normal volume) indicate a greater conviction, meaning prices are more likely to follow the trend in that direction.
Knowing the Term “Bounce” in Trading
Quoting belajartrading.co.id, Bounce in Forex is when the price bounces after approaching the Support or Resistance limit. Unlike a Breakout, a Bounce signals weakness in the continuity of the current price trend.
Bounces in Forex often occur when prices are still in a Sideways condition, although flat movement conditions do not last forever.
If one day there is a Breakout that penetrates the Support zone, it is likely that the price will experience a downtrend.
Conversely, if the Breakout breaks through the Resistance zone, it is likely that the price will experience an uptrend.
2 Steps to Predicting When It’s A Bounce or A Breakout
Quoting belajartrading.co.id, significant profits can be achieved if a trader can predict when a Bounce or Breakout will occur.
This ability is not based on mere speculation but includes systematic steps to chart the direction of price movement. These steps include:
- Identifying the location of Support and Resistance.
- Determining the points at which the price will likely bounce (Bounce) or break (Breakout) from the identified Support and Resistance.
What is a Breakout in Trading and How to Identify It?
Quoting investopedia.com, a breakout refers to when the price of an asset moves above the Resistance area or below the Support area. Breakouts indicate the potential for the price to start following the trend toward the breakout.
For example, an upward chart pattern breakout may indicate that the price will begin to follow an uptrend.
Breakouts with high volume (compared to normal volume) indicate a greater conviction, meaning prices are more likely to follow the trend in that direction.
According to ledger.com, breakouts are used in technical analysis to identify potential price movements beyond key support or resistance levels.
Traders recognize breakouts by studying historical price movements or analyzing chart patterns and line charts.
Investors can also gain insight into price trends by identifying existing resistance and support areas. This can be achieved by observing trading columns or using technical indicators, such as Moving Average, Bollinger Bands, or the Relative Strength Index (RSI).
Types of Breakout in Trading
Basically, breakouts can be categorized into two types: true and false. The following is a review of both and their differences, namely:
1. True Breakout
A true breakout occurs when the stock price movement successfully passes or breaks through a level without experiencing a reversal and continues to continue the breakout or rally.
In candlestick charts, a true breakout is confirmed when the candlestick body crosses or breaks the line, supported by increased volume. The more significant the increase in volume, the more it is believed to be a true breakout.
2. False Breakout
A false breakout occurs when the stock price movement appears to pass through a level but then reverses direction and does not continue the breakout.
Unlike the true breakout, in candlestick charts, a false breakout is confirmed when only the tail of the candlestick crosses or breaks the line without being followed by a significant increase in volume. An insignificant increase in volume may indicate a false breakout.
To avoid the risk of false breakouts, it is advisable to check prices in larger time frames, confirm with price action, and use auxiliary indicators.
Stock support and resistance areas tested frequently will tend to be stronger and more accurate than those rarely touched.
Getting to Know Breakout Trader
Breakout trader refers to traders who trade, open a trading position, or exit a trade when a breakout condition occurs.
Analysts from IG Markets assert that, generally, traders use breakout conditions to identify trends at an early stage.
By recognizing trends early, traders can spot profitable opportunities and design strategies to achieve significant returns.
What is the Difference Between A Breakout and A Trend Trader?
Quotinginvestopedia.com, a breakout trader, identifies areas or data points that are considered important and uses these areas as triggers to trade if the price moves through them.
A trend trader, on the other hand, looks for securities that are already moving up or down in value and tries to profit from the journey by buying or selling in the direction of the trend.
Examples of Breakout in the World of Crypto
It’s important to note that breakouts occur in all financial asset markets. According to James Chen, former director of investment & trading content at Investopedia, the most explosive price movement in breakout trading occurs when the price breaks out of a triangle, flag, or shoulder pattern.
Such an event was seen on the Bitcoin asset in November 2021. Charles Bovaird of Forbes stated that Bitcoin confirmed a Bullish Pennant breakout when the price broke out of the triangle pattern, followed by a strong and higher price movement.
Best Breakout Trading Strategies in Forex and Crypto
Quoting axi.com, one way of using breakout entries is by taking a trade when the price has broken out of a resistance level. For many traders, a breakout of a resistance level means that the price has momentum to go higher.
The thinking behind this is that a break of resistance could mean traders are bullish and will support price movement to higher levels.
While that’s not always the case, many traders use breakouts from these resistance levels as entry points.
On the other hand, you can use a breakout entry when the price has broken the support level. A break of support is usually seen as a signal that the price might drop further.
Some traders use this support breach to take advantage of the price drop.
By knowing what support and resistance levels are and how you can use them to identify when the price breaks out of them, you can use this entry strategy for trading.
Whether you’re using a demo or a live trading account, you can use the charting function on the MT4 trading platform to identify support and resistance levels.
It’s a good idea to try and identify support and resistance levels on different instruments at different timescales. Once familiar with and confident in identifying these levels, you might find it easier to recognize price breakouts.
Price breakouts are just one of the many entry strategies you can use for your trades.
Another important consideration for you as a trader is that while trade entries are important, they are only one component of your trade.
It is important to have a solid entry strategy. However, risk management and a rigorous exit strategy are equally important. Combined entry-risk management and exit strategies can help you become a smart trader.
When is the Best Time to Do a Breakout in Trading?
Quoting axi.com, breakouts can be traded in any time frame. You can break out trade below multi-year support levels and sustain the trade for several months.
However, breakout trading tends to be more popular among short-term traders because they try to capture momentum and profit from sudden market movements within a short period.
It’s easier to understand the market and its momentum when trading on lower than higher times.
Conclusion
In conclusion, it is important to understand the concept of breakouts in trading. With a good understanding of breakouts, traders can identify opportunities and manage risk more effectively.
However, it is important to remember that trading always involves risk, and success cannot be guaranteed. As such, traders are strongly advised to adopt a cautious approach and adhere to discipline in executing trading strategies.
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