Traders use the term ‘breakout’ to describe when the price of something moves above or below a predetermined support or resistance level.
That level can be anything from a prior high/low, key RSI support/resistance or any other key level on one of the many indicators available on the BTSE trading platform.
The purpose of this article is to show you how to do trade breakouts and also present a critique of its merits and flaws from the point of view of the author.
- A breakout is when the price moves beyond a predetermined support or resistance level.
- A breakout strategy aims to catch the start of a new trend or trend reversal.
- The significance of a breakout will depend on the significance of the breached support/resistance level.
- Breakout traders can be easily fooled by market manipulators.
- The predictive quality of breakout signals can be improved by combining price breakouts with other confirmatory indicators like RSI and volume.
- Trading false-breakouts is an equally popular contrarian strategy.
- Trading post-breakout pullbacks can reduce risks of false signals.
How to Trade Breakouts
In order to trade a breakout, you first need to identify a level that you want to see a particular data point break out of. For the purposes of this example, let’s choose price as the data point.
Step 1: Load up a price chart on the BTSE trading platform.
Here we have cherry-picked an example immediately prior to when a profitable breakout signal occurred in early 2019.
Step 2: Identify a key support or resistance level
- In late March of 2019, BTC/USD price was trending sideways.
- Price had already failed to break above $4,200 on three occasions.
- Therefore, $4,200 became a breakout resistance level to watch.
For more information about support and resistance levels, please refer to our article titled: Beginner’s Guide to Trendlines.
Step 3: Buy when the price breaks above resistance.
- This can be done by keeping a close eye on the price and reacting quickly.
- It can also be done by placing a STOP BUY order on the BTSE platform.
- This order will enter a bid at $4,250 when the price breaks above $4,200.
- By doing this a trader can specify how much of a premium they are willing to pay following the breakout.
- Alternatively, traders might choose to set market orders instead of limits by clicking the “Market” tab.
- Predatory traders and aggressive algorithms have been known to “fish for stops” by artificially pushing price past key levels to trigger stop orders.
- This causes a lot of false breakout signals and can result in heavy losses for breakout traders.
- Traders can increase the accuracy of their breakout signals by combining price action with other indicators such as volume and RSI.
Filtering Breakout Signals With Volume And RSI
Not every breakout signifies the start of a new trend or trend reversal. In fact, blindly following every breakout can prove to be a very unprofitable strategy.
However, by combining price breakouts with other indicators such as volume and RSI, we can set a higher trade entry requirement and reduce the number of false signals we get.
- Buy on a break of resistance; AND
- A break of 80 on the 14-day RSI; AND
- Higher than average volume
For more information about using RSI, please refer to our article titled: The Beginner’s Guide to Relative Strength Index (RSI).
How to Trade Post-Breakout Pullbacks
Breakouts are dangerous trades to make. The moment that price breaks resistance or support is usually accompanied by a flurry of market activity that typically causes wild price swings.
These price swings can often result in novice traders reacting too slowly and FOMO buying the top of false breakouts.
One strategy to overcome this is to trade the pullback that sometimes occurs after a breakout of a key level.
Post-breakout pullbacks often consolidate for a period at the key level and can present traders with ample time for trade entry and often a better entry price than trading the breakout itself.
- Wait for a breakout of a key level to occur.
- Enter a trade only after price pulls back to that breakout level.
Of course, not all breakouts pull back to their original breakout levels. Therefore, traders using this strategy might risk missing some breakout opportunities. This is the trade-off for fewer false-breakout signals and often better entry prices.
How To Trade False-Breakouts
False breakouts are a powerful reversal signal and a valuable tool for traders looking to range trade or pick tops and bottoms.
A false breakout occurs when the price moves beyond a support or resistance level but lacks the momentum to continue in the same direction.
Traders might look to:
- Short when the price breaks above resistance and then back below
- Buy when the price breaks below support and then back above
See below, another cherry-picked example from early 2020:
- $10,395 was the prior high resistance.
- In early February, the price momentarily broke above this resistance on two occasions but lacked the momentum to hold the breakout.
- Note that these breakouts occurred with only average volume.
- Traders may have looked to go short when the breakout dipped back below the resistance level on either of the two occasions.
How to Exit Breakout Trades
So far we have only spoken about trade entry using breakouts and false breakouts. However, every trade should ideally have a predetermined exit plan before entering.
Every trader has their own risk management rules and this will invariably guide their stop loss and exit strategies.
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