Understanding breakouts and being aware that there are fakeouts
What is a breakout?
A breakout is divided into two scenarios. The price may move higher than the resistance level or lower than the support level. A breakout is an unexpected directional price movement that is usually succeeded by more volatility and volume. Breakouts are not objective because traders are not all the same. Breakouts tend to be subjective because not every trader knows or uses one single support or resistance level. Also, a breakout can indicate prices that are typical to start a trend in a breakout direction.
The upside breakout and downside breakout
Breakout directions are essential indicators of potential upcoming price trends. It is helpful to know for traders when they are unsure which move is the best to make. An upside breakout means that a price’s trend will be more. An upside breakout also suggests a long or exit short positions. As the resistance level breaks, it becomes a support level if the price has a correction or pullback.
A downside breakout, also known as a breakdown, means that the price’s trend will decline. When this happens, it is suggested that a trader should go for short or exit long positions. As the support level breaks, it becomes a resistance level if the price has a correction or pullback.
Breakouts with massive volume, when compared to the expected volume, tend to have more conviction, and the price tends to trend more in that direction. Breakouts with low volume compared to the average volume tend to show weaker conviction, and the price tends to trend more in that direction. These breakouts are more susceptible to failure.
Learning how to trade breakouts
Once the price becomes lower than the resistance level or higher than the support level, a breakout may potentially happen for a period. Traders take advantage of the resistance and support level that becomes a line to make their entry points and place their stop losses.
Two possible things may happen once the support or the resistance level breaks. First, the waiting traders enter. Second, traders with stop losses get stopped out.
What happens when there is a breakout?
An increase in people who buy and sell means more volume. More volume means a vast number of people taking advantage of breakout levels. Patterns such as rectangles, triangles, pennants, and the like form when there is a price movement. A support or resistance level form as well. These are the ones that traders monitor. Furthermore, traders go long if the price breaks higher than the resistance and go short if the price goes lower than the support level.
Once the breakout is done, the price may go back to the breakout point before going to the breakout direction again. Once an upside finishes, the price can retest the previous resistance level that already became a support level. The same concept is true with a downside breakout.
If you wonder why this happens, sometimes, short-term traders quickly take their profit right after buying the initial breakout. They sell to exit their long positions, which makes the price go back to the breakout point.
A fakeout, which is short for a failed breakout, is an occurrence when the price does not move back to the breakout direction. These are not uncommon and tricky. Instead of going steady in the direction of the breakout continuously, it goes in the opposite direction.
So, what can we say?
Yes, it is now more convenient to trade since we can do it anytime and even when we are home, but that does not mean that it is easy. Trading is tricky even for experienced traders!