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Understanding Breakout Trades

December 5, 2013 in Forex Articles

When a price breakout occurs, the market is telling you that the paradigm has shifted and that the previous idea of what was an appropriate value for the currency is now being revised higher or lower.  The market is also telling you that we can expect prices to continue in the same direction (the direction of the break) going forward.  We base this assumption on the fact that markets would not have been able to push prices through the significant resistance level if momentum in the currency was truly in the present in the previous direction.  Bullish breakouts occur when prices make an upward break of resistance, while bearish breakouts occur when prices make a downside break of support.

“When major areas of support become invalidated, it makes sense to initiate sell positions,” said Haris Constantinou, currency analyst at TeleTrade.  “When major areas of resistance become invalidated, it makes sense to initiate buy positions.”  The main logic here ultimately resides in the fact that we would expect prices to continue to move in the direction of the price breakout.

Increasing the Probability in Breakout Trades

Now that we understand the mechanics of a forex trading breakout, we next need to learn how to increase the probabilities in these trades so that we can maximize gains relative to the trading majority.  One way of doing this is to look at market volumes as these support or resistance breaks occur.  If trading volumes are low, it is a signal that a majority of the market is not behind the breakout move and that there is a possibility of a false break.

Because of this, it is generally prudent to wait for breakouts that are accompanied by higher trading volumes.  Higher trading volumes will show you that a majority of the investment community is in favor of the direction in which prices are moving.  This is a better indication that prices will continue in this direction in the future.  Without this confirmation, the probabilities for a successful trade are lower.

Additional Confirmation

In addition to this, forex breakout traders that tend to be successful will also be looking increased volatility after the breakout occurs.  After a significant break of support or resistance, follow through will depend on increases in volatility which are usually generated by stop losses that were put in place by traders on the wrong side of the break.  While these stop losses being triggered is a bad side for the traders losing money, it is actually a good thing for breakout traders as this is likely to propel prices in the direction of the breakout.

Traders looking to capitalize on developing trends should always remember to look for price breakouts as the first indication that the previous trend is changing.  Here, we looked at some of the factors involved when structuring these types of trades.

The BoMACD Trading Strategy

December 5, 2013 in Forex Articles

Broadly speaking, the BoMACD trading strategy uses two of the most commonly used technical indicators in the forex market:  The Moving Average Convergence Divergence (MACD), and Bollinger Bands (The “Bo” in the system).  If you have any experience trading in the forex markets, it is highly likely that you have heard of one or both of these technical indicators.  And, it should be understood that there is a reason for this.  If these indicators were not widely viewed, tested and shown to be reliable for forecasting future price activity in the forex markets, why would so many market experts use them on a regular basis?

The fact is, these technical indicators have stood the test of time and weathered all of the testing and research that traders have conducted when studying these trading tools.   For these reasons, it will be highly beneficial for traders to understand the basics of how and why these indicators work (and what they seek to identify) so that a firm understanding of the associated trading methods can be used and profits can be maximized relative to losses in your trading account.

Combining Indicators

“In the most basic sense,” said Rick Bartlett, a currency analyst, “The BoMACD strategy looks to combine two of the most reliable technical indicators in order to construct high probability trading strategies.”  While each of these indicators can present some highly valuable trading signals on their own, combining these tools together can give even stronger signals, allow traders to remove low probability trading scenarios and instead focus on the trades that are most likely to bring about a successful result.  So, why does this combination of technical tools help us to expand on probabilities for successful trades?

Each tool works great on its own, but in combination their powers in market forecasting rise exponentially.  Bollinger Bands essentially give traders a range in which prices are likely to fluctuate over a given period of time.  Prices are unlikely to rise above the upper band for very long.  Likewise, they are unlikely to fall below the lower Bollinger Band for very long.  This is useful in setting profit targets and stop losses.  In long positions, the profit target can be set near the upper Bollinger Band while the stop loss can be set below the lower Bollinger Band.  In short positions, the profit target can be set near the lower Bollinger Band while the stop loss can be set above the lower Bollinger Band.

The MACD comes in when we are looking to identify trend direction (which becomes the basis for the decision to place a long trade or a short trade).  When the MACD is seen above the MACD histogram, buy positions should be initiated, as this implies positive momentum in the markets.   When the MACD is seen below the indicator histogram, sell positions should be initiated, as this implies negative momentum in the markets.