Fakeout is a term used in technical analysis (TA) to refer to a situation where a trader enters a position expecting a price movement that does not happen in the end. In fact, in most cases, fakeout is used to refer to a situation where the price moves against a trading idea or signal.
Fakeouts can also refer to “fake breakouts,” or false breakouts, where prices break through a technical price structure, only to quickly reverse course. This can cause considerable losses. Technical analysts can identify patterns that fit perfectly into their strategy, and appear to be playing as expected. However, prices can reverse very quickly due to external factors, and trades can quickly turn into heavy losses. Thus, in anticipation of a fakeout, many traders will plan their exit strategy and place a stop-loss order before entering a trade. In fact, this is a fairly common strategy for basic risk management.
In order to reduce the risk of fakeouts, many traders will limit the amount of capital they can risk in certain trades. As a general rule, many will not risk more than 1% of their trading capital in a single trade. So does this mean they enter a certain position with only 1% of their capital? Not. It simply means that if the market reverses and their stop-loss is hit, they will only lose 1% of their trading capital in one position.
Another strategy that helps reduce the potential effect of a fakeout is to rely on some technical indicators to enter a trade. Technical analysts can set very strict requirements for what are considered “trading signals” in their strategy. If one indicator gives a signal, it may not be a signal to buy or sell the asset itself. However, if several indicators say the same thing, this might confirm the signal strength. Even so, there are no guarantees when it comes to financial markets, and the signal that looks the strongest can also turn into a fakeout.