In order
to fade breakouts, you need to know where potential fake outs can occur.
Potential
fake outs are usually found at support and resistance levels created through
trend lines, chart patterns, or previous daily highs or lows.
Trend lines
In fading breakouts, always remember that there
should be SPACE between the trend line and price.
If there
is a gap between the trend line and price, it means price is heading more in
the direction of the trend and away from the trend line. Like in the example
below, having space between the trend line and price allows price to retrace
back towards the trend line, perhaps even breaking it, and provide fading
opportunities.
The SPEED of price movement is also very
important.
If price
is inching like a caterpillar towards the trend line, a false breakout may be
likely. However, a fast price movement towards the trend line could prove to be
a successful breakout. With a high price movement speed, momentum can carry
price past the trend line and beyond. In this situation, it is better to step
back from fading the breakout.
How do we
fade trend line breaks?
It's very
simple actually. Just enter when price pops back inside.
This will
allow you to take the safe route and avoid jumping the gun. You don't want sell
above or below a trend line only to find out later that the breakout was real!
Using the
first chart example, let's point out possible entry points by zooming in a
little.
Chart Patterns
Chart
patterns are physical groupings of price you can actually see with your own
eyes. They are an important part of technical analysis and also help you in
your decision-making process.
Two
common patterns where false breakouts tend to occur are:
·
Head and Shoulders
·
Double Top/Bottom
The head and shoulders chart
pattern is actually one of the hardest patterns for new traders to spot.
However, with time and experience, this pattern can become an instrumental part
of your trading arsenal.
The head and shoulders pattern is
considered a reversal. If formed at the end of an uptrend, it could signal a
bearish reversal. Conversely, if it is formed the end of a downtrend, it could
signal a bullish reversal. Head and shoulders are known for generating false
breakouts and creating perfect opportunities for fading breakouts.
False breakouts are common with this pattern
because many traders who have noticed this formation usually put their stop
loss very near the neckline.
When the
pattern experiences a false breakout, prices will usually rebound. Traders who
have sold the downside breakout or who have bought the upside breakout will
have their stops triggered when prices move against their positions. This
usually is caused by the institutional traders who want to scrape money from
the hands of individual traders.
In a head
and shoulders pattern, you can assume that the first break tends to be false.
You can
fade the breakout with a limit order back in the neckline and just put your
stop above the high of the fake out candle.
You could
place your target a little below the high of the second shoulder or a little
above the low of the second shoulder of the inverse pattern.
The next pattern is the double top or the double bottom.
Traders
just love these patterns! Why you ask? Well it is because they're the easiest
to spot!
When
price breaks below the neckline, it signals a possible trend reversal. Because
of this, plenty of traders place their entry orders very near the neckline in
case of a reversal.
The
problem with these chart patterns is that countless traders know them and place
orders at similar positions. This leaves the institutional traders open to
scrape money from the commoner's hands.
Similar
to the head and shoulders pattern, you can place your order once price goes
back in to catch the bounce. You can set your stops just beyond the fake out
candle.
What kind
of market should I fade breakouts?
The best results tend to occur in a range-bound
market. However, you cannot ignore market sentiment, major news events,
common sense, and other types of market analysis.
Financial
markets spend a lot time bouncing back and forth between a range of prices and
do not deviate much from these highs and lows.
Ranges
are bound by a support level and a resistance level, and buyers and sellers
continually push prices up and down within those levels. Fading the breakouts
in these range-bound environments can prove to be very profitable. However at
some point, one side is eventually going to take over and a new trending stage
will form.
