In today’s article, we will dive deeper into breakouts and fakeouts and learn how to use them to make better trading decisions.
Breakouts can be one of the most profitable trading entries in both the crypto and the stock market. However, the market is great at giving fake signals. In today’s article, we dive into breakouts and fakeouts. Let’s look at the differences, and how to tell one from the other!
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What Are Breakouts in Crypto and Stock Markets?
Breakouts are usually the starting point of a strong move. Therefore, traders use them as an indicator in technical analysis to determine which coins or stocks they should be buying, and when.
A breakout happens when an asset moves above a resistance level, trendline or key area, usually with increased volume. When the price breaks the level, many traders rush to open new long positions, while others immediately close their shorts. This causes an increase in volume and sends prices higher.
The trade in the tweet above shows a perfect example of a bullish trendline breakout. As you can see, the price broke out of the trendline, retested it, and went on to the first target in this trade. Patterns like these occur in all kinds of market environments, even in bear markets.
How to Identify Breakout Trading Patterns
There are many different breakout trading patterns, like the head and shoulders or the rising wedge pattern. Beginners are familiar with most of these patterns because of popular forex trading courses teaching the basics. The image below should refresh your memory!
Traders use price action patterns, ranges, trendlines and even moving averages to identify areas of interest. When the price traverses the range limits, breaks the pattern or crosses the moving average, they look for signals that confirm the breakout.
In any case, identifying breakout patterns requires time, technical analysis skills and an eye for detail.
What Are False Breakouts (Fakeouts) in Crypto and Stock Markets?
As discussed, markets are great at presenting fake signals, so it is important to look for confirmation of a breakout. Without any confirmation sign, it is likely that the breakout will fail and become a fakeout like the one we saw at the turn of the month.
In short, a false breakout happens when the price breaks above or below a resistance level, trend line or area of interest, but then fails to hold it. This usually happens because either the area was not as significant as the trader thought or large players engineered the breakout to fill their orders.
Also Read: What Is the Swing Failure Pattern and How to Use It in Trading?
False Breakouts Are Key Trading Opportunities
Often, these false breakouts present a great trading opportunity. When a breakout fails, it is a strong indication that the market wants to trade in the opposite direction. Take the charts below as an example. We saw the price break out of the range, but without much success. After Ethereum fell back into the range, it didn’t take long before the range low was hit.
Fakeouts often present opportunities like that. When a breakout becomes a fake-out (by falling back into the range or chart pattern), you can safely bet on a visit to the lows. Again, this has to do with liquidity engineering, which you can read more about in this article.
How to Identify False Breakout (Fakeout) Trading Patterns?
Telling real and false breakouts apart is a very difficult process. In fact, false breakouts are often engineered to look like the real deal to lure traders into taking wrong positions. Nevertheless, there are a few things you can do to improve your accuracy.
Firstly, the obvious move is to wait for a few candles to close before positioning yourself. The longer price holds above the breakout area, the more likely it is to be a true breakout. In combination with this, zooming in to lower time frames is another place to look for extra confidence. The low time frames will — in the case of real breakouts — often print a quick retest of the breakout area before continuing further. They will also warn you early when the price starts to close back below the level. In any case, candle closes are a solid confirmation indicator.
Studying the current environment is also a great source of information on the authenticity of a breakout. In a bearish environment, breakouts have a higher chance of failing, so fake outs are more common. Bull markets are more likely to turn attempted breakouts into success.
Finally, as already discussed at the start of the article, volume is a great indicator to follow as well. Usually, strong breakouts happen on higher-than-normal volumes.
Using (False) Breakouts to Confirm Trade Ideas
Now that we know what to look for, we can use these signals to confirm trade ideas. If trader Fred already has a bearish outlook, he can look for a false breakout to enter his trade and add more confidence to his already bearish thesis.
The same is true for trader Julia, who believes Ethereum will go up. She looks for a failed breakdown to enter her long trade and to add confidence to her already bullish trading plan.
False Breakouts Around Events or Economic Situations
Trading around economic situations or events is incredibly difficult, but they can provide just the right amount of volatility to paint a false breakout. The author personally stays away from trading these events, but when the volatility around an event creates a false breakout, traders may profit by taking relevant positions. Just proceed with caution and exercise risk management, as the volatility may stick around for longer than you might expect!
Entry Point When Trading Fake-outs
There are two popular ways to enter fake-out trades. Trader Henry chooses to short BTC as soon as it falls back into its range, while Zahra chooses to wait for a retest of the range high or consolidation below it before getting in.
Just like with trading a breakout, there are reasons to wait (and not to wait) for confirmation. A confirmation gives you more certainty, but it might never come. When a fake-out turns out to be a real breakout, waiting too long for confirmation may cost you a good opportunity. Fake fake-outs (real breakouts mistaken as fakeouts) happen a lot!
Stop Loss on Fake Breakouts
As said earlier, using risk management when building trading strategies for breakouts (and false breakouts) is incredibly important. Traders choose to place their stop loss based on market structure or on a fixed percentage and gradually move it as the trade moves in their favor. Finding out which method works for you takes time and research. Experiment with different approaches to find out what works best for you.
Targets in Fake-out Trading
As discussed earlier, when a fake-out happens, the price often makes a quick pullback to the other extreme of the range or price action pattern. Most traders, therefore, use the other end of the range or pattern as a target or use Fibonacci to plot further targets.
Also Read: What Is the Golden Ratio? The Beauty of Fibonacci Golden Pocket
Volatility Breakout
Volatility is another key factor traders use to spot trading opportunities. It generally picks up around breakouts, so monitoring the volatility of an asset can help you spot breakouts even when you are not paying attention to the area. Traders use indicators like Bollinger bands or the average true range to spot spikes in volatility.
Also Read: The Best Technical Indicators for Crypto and Stocks
How to Trade Breakout or Fake out Using Trading Indicators?
In addition to support and resistance levels, trendlines, price action patterns and consolidation ranges, price can also present breakout or fake-out opportunities in trading indicators. Sometimes, it breaks a key moving average or key levels of the RSI as a sign.
Breakout traders can deploy the same strategies they use to trade breakouts from chart patterns or resistance levels - as long as they keep in mind that moving averages are not fixed to a certain price level, and, therefore, may require traders to move their stops from time to time. If you are day trading, you might prefer to manually monitor the trade, rather than having a hard stop loss in place.
Closing Thoughts
Trading breakouts or false breakouts (fakeouts) can be incredibly fruitful, and there are a few ways to tell the one from the other. Traders can confirm them by using volume, lower time frames or retests to avoid surprises.
Nevertheless, the market is spending the most of its time consolidating. It can take quite some time before a breakout opportunity presents itself - but the wait is generally worth it!
In the meantime, we suggest trying day trading strategies, monitoring price movement, reading more CoinMarketCap Academy articles and exploring other interests. Good luck!
Writer’s Disclaimer: This article is based on my limited knowledge and experience. It has been written for educational purposes. It should not be construed as advice in any shape or form.
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