Just like
breakouts on your face, the nice thing about breakout trading is that
opportunities are pretty easy to spot with the naked eye! Unlike the former,
you don't even have to look in the mirror!
Once you
start getting used to the signs of breakouts, you'll be able to spot good
potential trades fairly quickly.
Chart Patterns
By now
you should be accustomed to looking at charts and recognizing familiar patterns
that indicate a reversal breakout. Here are just a few:
·
Double Top/Bottom
·
Head and Shoulders
·
Triple Top/Bottom
For more information check out our lesson on chart patterns.
In
addition to chart patterns there are several tools and indicators you can use
to supplement your case for a reversal breakout.
Trend Lines
The first way to spot a possible breakout is to draw trend lines on a chart. To draw a trend line you simply look at a chart and
draw a line that goes with the current trend.
When
drawing trend lines it is best if you can connect at least two tops or bottoms
together. The more tops or bottoms that connect, the stronger the trend line.
So how
can you use trend lines to your advantage? When the price approaches your trend
line, only two things can happen. The price could either bounce off the trend
line and continue the trend OR price could breakout through the trend line and
cause a reversal. We want to take advantage of that breakout!
Looking
at the price is not enough however. This is where using one or more of the
indicators mentioned earlier in this lesson could help you tremendously.
Notice
that as EUR/USD broke the trend line MACD was showing bearish momentum. Using
this information we can safely say that the breakout will continue to push the
euro down and as traders, we should short this pair.
Channels
Another way to spot breakout opportunities is to draw trend channels. Drawing
trend channels are almost the same as drawing trend lines except that after you
draw a trend line you have to add the other side.
Channels
are useful because you can spot breakouts on either direction of the trend. The
approach is similar to how we approach trend lines in that we wait for the
price to reach one of the channel lines and look at the indicators to help us
make our decision.
Notice that the MACD was
showing strong bearish momentum as EUR/USD broke below the lower line of the
trend channel. This would've been a good sign to go short!
Triangles
The third
way you can spot breakout opportunities is by looking for triangles. Triangles
are formed when the market price starts off volatile and begins to consolidate
into a tight range. Our goal is to position ourselves when the market
consolidates so that we can capture a move when a breakout occurs.
There are
3 types of triangles:
1. Ascending
triangle
2. Descending
triangle
3. Symmetrical
triangle
Ascending Triangles
Ascending
triangles form when there is a resistance level and the market price continues
to make higher lows. This is a sign that the bulls are slowly starting to gain
momentum over the bears.
The story
behind an ascending triangle is that each time the price reaches a certain
high, there are several traders who are convinced about selling at that level,
resulting in the price dropping back down.
On the
other side, there are several traders who believe the price should be higher,
and as the price begins to drop, buy higher than its previous low. The result
is a struggle between the bulls and bears which ultimately converges into an
ultimate showdown...
What we
are looking for is a breakout to the upside since ascending triangles are
generally bullish signals. When we see a breach of the resistance level the
proper decision would be to go long.
Descending Triangles
Descending
triangles are basically the opposite of ascending triangles. Sellers are
continuing to put pressure on the buyers, and as a result, we start to see
lower highs met by a strong support level.
Descending triangles are
generally bearish signals. To take advantage of this, our goal is to position
ourselves to go short if the price should breakout below the support level.
Symmetrical Triangles
The third
type of triangle is the symmetrical triangle. Rather than having a horizontal
support or resistance level, both the bulls and the bears create higher lows
and lower highs and form an apex somewhere in the middle.
Unlike
the ascending and descending triangles which are generally bullish and bearish
signals, symmetrical triangles have NO directional bias. You must be ready to
trade a breakout on either side!
In the
case of the symmetrical triangle, you want to position yourself to be ready for
both an upside or downside breakout. A perfect time to use the
one-cancels-the-other (OCO) order! Don't remember what an OCO order is? Go
review your types of orders!
In this
scenario, GBP/USD broke out on the upside and our long entry was triggered.
Breaking down the Triangle Breakouts
To help
you memorize the different types of triangle breakouts, just think of facial
breakouts.
Ascending
triangles usually breakout to the upside. So when you think of ascending
triangles, think of breaking out on your forehead.
Descending
triangles usually breakout to the downside. So when you think of descending
triangles, think of breaking out on your chin.
Symmetrical
triangles can break either to the upside or the downside. So when you think of
symmetrical triangles, think of breaking out on both your chin and forehead.
Here's a
quick and disgusting memory tickler:
Ascending
triangle = Forehead breakout
Descending
triangle = Chin breakout
Symmetrical
triangle = Forehead OR chin breakout
EWWWW!!!!
Gross eh?
But we bet you'll remember it!
