Breakout strategies are one of the most commonly used type of strategies among professional and retail traders. In my opinion, it rightly should be.
Of course, profitability is the main key to judge the different types of strategies and supports and resistances have proven to be such. However, I do like breakout types of strategies because of one thing – it makes sense.
When you come to think of it, supports and resistances are levels which the market deem as either too expensive or too cheap. This drives market participants to either sell at a certain level or buy at another causing price to bounce back within an accepted price range. What happens during a breakout should interest traders. During a breakout, price that was considered either too cheap or too expensive is disregarded as such. Price trades beyond the accepted range going a certain direction. This means that something is happening in the market. It is either that the bears or bulls are giving up a certain price point and is willing to trade at much higher or lower price. That is what causes a breakout.
Momentum and Breakouts
Although breakouts are excellent scenarios to build a strategy around, most traders find it hard to determine whether a support or resistance area is about to be broken or if price just touched or pierced it, only to reverse within the range.
The key to having a higher probability breakout trading is looking for momentum. But what is it really? What is momentum? In science, momentum is a product of two things – mass and velocity. The same is true with trading. Momentum is still mass and velocity. However, we identify it in a different manner. In this case, mass is the volume of trades and velocity is the speed of how price changed. What usually takes place in three, four or five, even ten candles, could take place in just one candle. The change in price levels, the volume of transactions, it all happens in just one candle. The result a long, full-bodied candle with just a small wick at either side. That is a momentum candle.
Trade breakouts only when there is momentum behind it. You would rather bet on a speeding truck to break through a brick wall rather than a scooter, right?
Trade Strategy Concept
Knowing that momentum candles are an indicator of a high probability breakout, we will be taking breakout trades wherein it was a momentum candle that broke through it.
But first, we need to be able to identify our supports and resistances. To aid us in this, we will be using a custom indicator that helps us find these – the SupportResistanceLevels indicator.
This indicator conveniently plots horizontal supports and resistances, with blued dots as supports and red dots as resistances. These are based on the previous swing highs and lows, which is how a normal support and resistance is plotted.
Then, we wait for a full-bodied momentum candle to break through it and close outside of the range.
Our entries will be pending stop entry orders. This is because often times, even with a momentum candle, there will be a slight retest of the previous support or resistance when it is broken. During these phase, we still don’t know if it is a real breakout or a fake-out. It is better to enter when the breakout is confirmed, and we do this by using pending stop orders.
Support Resistance Levels
Currency Pair: any
Timeframe: 1-hour chart and above
Trading Session: any
Buy (Long) Trade Setup Rules
A bullish momentum candle should break and close above the resistance level (red dots)
Set a pending buy stop order a little above the high of the breakout candle, which should be triggered on the next candle.
If stop order is not triggered on the next candle, cancel the buy stop order
Set the stop loss below the resistance level
Set the take profit at 2x the risk on the stop loss
Sell (Short) Trade Setup Rules
A bearish momentum candle should break and close below the support level (blue dots)
Set a pending sell stop order a little below the low of the breakout candle, which should be triggered on the next candle.
If stop order is not triggered on the next candle, cancel the sell stop order
Set the stop loss above the support level
Set the take profit at 2x the risk on the stop loss
This strategy is a working strategy used among many breakout and order flow traders. Traders who do this manually would often determine the recent unbroken swing highs and lows and wait for breakouts from there predetermined support and resistances.
It is also a common practice to wait for retests. Some traders go to the lower timeframes to determine the retest and enter at a better price at the retest. However, this is an advanced technique. Buying at the break of the candle’s high or selling at the break of the candle’s low is the intermediate technique, which also works well.
If you would notice, of the four sample trades, three of it retraced near the area of the support or resistance, represented by the wicks. Those are our retests. Only one had almost no wick, which was the first buy trade. This usually occurs if the momentum candle is too strong, or if price didn’t stall when the candle is about to close.
I hope this strategy has educated some newbie traders. This is a pretty basic strategy but only that it uses the aid of an indicator that identifies swing highs and lows and draws supports and resistances based on it.
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