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The breakout strategy involves two phases. The first phase involves waiting for the market to consolidate. A consolidated market becomes very choppy and directionless, the trader waits, and watches the market. The breakout trader is a patient trader. This strategy is largely based on patience and timing.
Perhaps you have traded a version of the breakout trade in the past.There are many versions of this trading set-up, so you might know the drill: You wait and watch the market when it is calm. You are waiting when
the market is trading within a tight range. Then, eventually the market breaks out and extends beyond the restricted range and rockets off in one direction for a strong, sustained trending move. This is where the wellplaced entry will capture a quick profit at the very least, and may even afford an early entry into a strong, sustained trend.
Identifying the Transition
As a breakout trader you take advantage of the natural rhythm of the market and, in particular, the transition between the boring, restricted movement of the range-bound market and the fierce strong moves of the trending market. When will you know that the market is changing?
How do you determine that the consolidation period is over? Will the market offer a clue when it is about to move into a trending phase? Is it possible to determine when the market ends the directionless phase and begins the strong trending phase? The answer is yes, and you will use your old friend, the support and resistance zone.
The support and resistance zone will be the threshold by which you judge the movement of the market once again. This time the support and resistance zone will mark the line in the sand for the naked version of the breakout trade—the last-kiss trade.
The first step of the last-kiss trade is to identify the consolidation zone. One way to visualize a consolidation zone is to draw a box on the chart. This box will contain the choppy movements of the directionless market. This box should encompass the market movement during the choppy, drifting-market phase (see Figure 5.4).
FIGURE 5.4 This box on the USD/JPY four-hour chart may be used to contain the price action in the market during the drifting-market phase.
[You must be registered and logged in to see this image.]
The important thing to remember here is that the box, which contains themarket activity, is formed by both a support zone and a resistance zone. This box of market activity should pop out on the chart—it should be obvious that the market is stuck between both of the zones. Typically, there will be several touches on either side of the zones. In Figure 5.5 we see that there are three touches at the top of the box (market found resistance) and two touches at the bottom of the box (market found support).
FIGURE 5.5 The consolidation zone should be very obvious. Notice how the market bounces off of the support zone and the resistance zone several times on the four-hour USD/JPY chart. Twice the market finds support at the bottom of the box and three times the market finds resistance at the top of the box.
[You must be registered and logged in to see this image.]
The consolidation phase inside of the box may continue for some time.However, once the market breaks out toward either the support zone or the resistance zone, the last-kiss trader takes notice. For many breakout
traders, themove outside of the consolidation box will trigger a trade. However, the last kiss trade is not triggered at this stage.
A close examination of a typical, standard breakout trade may be in order. The typical breakout strategy will follow a series of events. First, the market consolidates, and a box is drawn around the consolidation. Second,
the market pushes beyond either the support zone or the resistance zone to trigger a trade (see Figure 5.6).
FIGURE 5.6 This four-hour chart on the USD/CHF shows a standard breakout trade. The trade is triggered once the market moves beyond either the support zone or the resistance zone. In this example, the market breaks out to the upside, signaling a buy trade.
[You must be registered and logged in to see this image.]
This move beyond the zone is the trade signal. In fact, standard breakout traders often place buy stop orders above the resistance zone, and sell stop orders below the support zone in anticipation of the breakout.
There are, of course, varying degrees of differences among breakout strategies; however, the core principle that guides breakout strategies is this: Once the market breaks out beyond a zone, a trade is triggered.
However, the standard breakout strategies have a very common problem.Many breakout trades end up as losing trades because they are triggered by a fake-out. What is a fake-out, you ask?
by Alex Nekritin and Walter Peters
Perhaps you have traded a version of the breakout trade in the past.There are many versions of this trading set-up, so you might know the drill: You wait and watch the market when it is calm. You are waiting when
the market is trading within a tight range. Then, eventually the market breaks out and extends beyond the restricted range and rockets off in one direction for a strong, sustained trending move. This is where the wellplaced entry will capture a quick profit at the very least, and may even afford an early entry into a strong, sustained trend.
Identifying the Transition
As a breakout trader you take advantage of the natural rhythm of the market and, in particular, the transition between the boring, restricted movement of the range-bound market and the fierce strong moves of the trending market. When will you know that the market is changing?
How do you determine that the consolidation period is over? Will the market offer a clue when it is about to move into a trending phase? Is it possible to determine when the market ends the directionless phase and begins the strong trending phase? The answer is yes, and you will use your old friend, the support and resistance zone.
The support and resistance zone will be the threshold by which you judge the movement of the market once again. This time the support and resistance zone will mark the line in the sand for the naked version of the breakout trade—the last-kiss trade.
The first step of the last-kiss trade is to identify the consolidation zone. One way to visualize a consolidation zone is to draw a box on the chart. This box will contain the choppy movements of the directionless market. This box should encompass the market movement during the choppy, drifting-market phase (see Figure 5.4).
FIGURE 5.4 This box on the USD/JPY four-hour chart may be used to contain the price action in the market during the drifting-market phase.
[You must be registered and logged in to see this image.]
The important thing to remember here is that the box, which contains themarket activity, is formed by both a support zone and a resistance zone. This box of market activity should pop out on the chart—it should be obvious that the market is stuck between both of the zones. Typically, there will be several touches on either side of the zones. In Figure 5.5 we see that there are three touches at the top of the box (market found resistance) and two touches at the bottom of the box (market found support).
FIGURE 5.5 The consolidation zone should be very obvious. Notice how the market bounces off of the support zone and the resistance zone several times on the four-hour USD/JPY chart. Twice the market finds support at the bottom of the box and three times the market finds resistance at the top of the box.
[You must be registered and logged in to see this image.]
The consolidation phase inside of the box may continue for some time.However, once the market breaks out toward either the support zone or the resistance zone, the last-kiss trader takes notice. For many breakout
traders, themove outside of the consolidation box will trigger a trade. However, the last kiss trade is not triggered at this stage.
A close examination of a typical, standard breakout trade may be in order. The typical breakout strategy will follow a series of events. First, the market consolidates, and a box is drawn around the consolidation. Second,
the market pushes beyond either the support zone or the resistance zone to trigger a trade (see Figure 5.6).
FIGURE 5.6 This four-hour chart on the USD/CHF shows a standard breakout trade. The trade is triggered once the market moves beyond either the support zone or the resistance zone. In this example, the market breaks out to the upside, signaling a buy trade.
[You must be registered and logged in to see this image.]
This move beyond the zone is the trade signal. In fact, standard breakout traders often place buy stop orders above the resistance zone, and sell stop orders below the support zone in anticipation of the breakout.
There are, of course, varying degrees of differences among breakout strategies; however, the core principle that guides breakout strategies is this: Once the market breaks out beyond a zone, a trade is triggered.
However, the standard breakout strategies have a very common problem.Many breakout trades end up as losing trades because they are triggered by a fake-out. What is a fake-out, you ask?
by Alex Nekritin and Walter Peters
