Trading with False Breakouts: Recognizing and Utilizing Breakout Failures

What is a False Breakout?

A breakout occurs when the price movement breaks through significant levels such as resistance, support, or psychological levels. A false breakout happens when the price movement fails to sustain the breakout and quickly reverses direction. This can be an opportunity for traders who capitalize on it, known as contrarian trading.

Why Do False Breakouts Occur?

1. 1. Battle Among Big Players:
   • At crucial levels like support or resistance, there is a battle among central banks, financial institutions, and big players.
   • Central banks may increase lot sizes to prevent prices from surpassing certain levels, while big players may change their direction if they feel unsupported.
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3. 2. Decreasing Momentum Post-Breakout:
   • After a successful breakout, momentum often diminishes due to market consolidation.
   • False breakouts occur when prices reverse due to a lack of strength to sustain movement post-breakout.

Example of False Breakout on GBP/USD

• 1. Bearish False Breakout Scenario:

  • In November 2007, GBP/USD breached the 2.1050 level but experienced a bearish engulfing afterward.
  • Prices plummeted to the 1.5 level a year later, 6000 pips from the false breakout level.

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• 2. Bullish False Breakout Scenario on EUR/USD:

  • On the weekly chart, several false breakouts can be seen at round number levels.
  • Note the reversal strength after the false breakout, especially at stronger levels.

False Breakouts in Sideways Conditions

• Example in Sideways Market:
  • In sideways market conditions, false breakouts often occur at support and resistance levels.
  • Traders can anticipate them by observing candlestick bar formations like pin bars, inside bars, or dojis.

Trading Strategy with False Breakouts

1. 1. Using Price Action:

   • Observe candlestick bar formations around support or resistance levels.
   • Entry can be made after confirmation from price movement and technical indicators.

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3. 2. Limit Orders and Stop Orders:

   • Contrarian traders tend to use limit orders near support or resistance levels.
   • Aggressive traders can use stop orders to capitalize on perfect breakout conditions but still require confirmation.

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5. 3. Analyzing Dominant Trends:

   • It's essential to know the dominant trend on higher time frames.
   • In an uptrend, sideways tends to break out at resistance, and vice versa in a downtrend.
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False breakouts frequently occur in the forex market, especially in sideways conditions. Trading strategies utilizing false breakouts require an understanding of price action, candlestick formations, and confirmation from technical indicators. Contrarian traders can use limit orders or stop orders based on their risk tolerance and trading preferences. Patience is crucial, waiting for confirmation before making decisions. With a careful approach, false breakouts can become profitable trading opportunities.

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