The breakout refers to an instance where the price action moves beyond a certain resistance level. After the price goes beyond this level the investment will generally be traded with a great amount of volume. As a result the value of the investment can be very volatile.
With a Breakout System, a trade is always taken in the direction that the market is moving at the time. It is usually entered via a pending order. A channel can be identified by using trend lines, joining the past supports/resistance, Andrew’s Pitch Fork, or Donchian channel.
When price breaks 2 weeks high/low, traders view it as a good indication that it will continue to trend further in the intended direction where more volume will be anticipated. A pending order is usually placed a few pips away from the previous high or previous low to participate early when a breakout is expected to occur.
Pros and Cons of a Breakout System
Breakout system will perform the best in a high volatility market conditions but tend to give away profits in a ranging or consolidation markets. This is because a greater false breakout occurrence will be encountered in that market condition.
Optimise Breakout Strategy to Filter Out False Breakouts
1. A higher probability of valid breakouts will be expected at European and US overlapped 12 00 – 16 00 hr GMT trading hours because these are the times where trading volume is largest in the forex market.
2. Using technical indicators to identify possible divergence to identify false breakouts and not to trade when a divergence appears.
Characteristics of a Breakout System
- Execution type is usually pending order - Small stop loss - May employ trailing stop - Draw-down can be high during ranging period - Can be traded in various time frames
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Warren examines commercial trading systems and has since started researching and analysing systems to uncover good systems which bring in consistent profits. By publishing all the research papers and detailed analysis online, he seeks to educate potential investors and traders on the world of trading the forex market with automated systems.