Breakout strategy is among the oldest entries in the book of forex technical analysis. It is old, but very robust, and with training and good risk management, can generate consistent returns in the long run. You have seen it before, the EUR/USD moving in sideways, then to break in either direction and switch to trending mode. Breakouts occur when the price decisively moves beyond established support and resistance zones. In the guide below, we will attempt to cut through noise and nonsense circulating on the internet and provide clear guides and trader tips to uncover all the secrets for consistent breakout profits.
So, what is a breakout in Forex?
At its core, a breakout trading strategy is when the price moves beyond a previously established support or resistance zone. These levels are areas on the price chart where the price bounced several times, meaning it is difficult for the price to move beyond those levels, and when it does, we call it a breakout. The breakout usually signals that one side has won the battle and pushed the price beyond the other side’s control. They also signal new, powerful trends and are often used by trend-following traders.
However, not all breakouts are equal, and more often than not, they fail. We call this phenomenon fakeouts. Fakeouts occur more than breakouts, making it critical to know the signs of genuine breakouts.
Three signs of a genuine breakout
As not all breakouts are created equal, there are three main sins to ensure your breakout has the highest chances of success. Here are three main factors:
- Volume – A Genuine breakout is usually accompanied by a significant volume surge, which acts as a fuel for the impulse.
- Volatility – Breakouts frequently occur during highly volatile markets, which makes it difficult to differentiate between just price spike and a breakout, meaning you need a trend confirmation tool like ATR or RSI.
- Session – Breakouts that occur during the London and New York sessions overlap have the highest chances of success because these hours provide the deepest liquidity, and major institutions are trading during these times.
Taking into account all these factors will provide a great starting framework to filter out most of the fakeouts and only focus on genuine setups with high success rates.
A simple breakout system explained
Seeing the price break a level is one thing, and to trade on it is a completely different matter. Having a structured plan with a list of rules and requirements for a trade is crucial. A solid breakout system helps traders open trading positions, manage open trades, set proper risk limits using a well-placed stop-loss, and close trades when in profit.
The one important warning here is that breakout systems have a lower win rate of around 36-40%, meaning most of the trades will be losing trades, which might become very difficult for psychology. However, when sticking to your system, profitable trades will outperform losing ones in the risk-reward ratio.
Here are basic rules for a standard breakout setup, no matter the market and timeframe:
- Entry trigger – The most reliable entry criterion is to wait for the price to retreat and enter only when it retests the zone and continues in the direction of a breakout. This way, you avoid fakeouts and ensure that you follow setups with the highest potential.
- Stop-loss placement – stop losses are usually placed near the recent price swings, above the recent high for sell trades, and below the recent swing low for buy orders.
- Profit target – Setting a logical take profit 2-3 times of the stop loss is a good idea to avoid greed.
- Trailing stops – If you want, you can follow the price as it makes swings using a trailing stop and ensure you always lock in profits to avoid experiencing losses when the price decides to go back.
Apart from these three main criteria, traders should use confirmation and be patient to trade the best setups.
Common Breakout setup types
There are many different types of breakouts, but the most popular, apart from support and resistance zone breakouts, are trendline breakouts, chart pattern breakouts, and volatility or news breakouts. Trendline breakouts occur when the price breaks the well-established trendline. This can signal major turning points and should be approached carefully, as the price might break the trendline only to return to the main direction later. Chart pattern breakouts occur when the price breaks patterns like triangles, flags, rectangles, and so on. A news breakout occurs when major news releases force prices to swing in one direction, violently breaking all previous levels. Data like NFP and CPI can throw the market into imbalance and cause breakouts as well.
