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.
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.