To fade breakouts, you must first understand where possible fakeouts can occur.
Potential fakeouts are typically discovered at support and resistance levels formed by trend lines, chart patterns, or past daily highs or lows.
Always remember to provide SPACE between the trend line and the price when fading breakouts.
If there is a gap between the trend line and the price, it indicates that the price is moving away from the trend line and more in the direction of the trend.
As shown in the example below, having gap between the trend line and the price allows the price to retrace back to the trend line, maybe breaking it, and providing fading possibilities.
The SPEED of price movement is also critical.
A false breakout is possible if the price is crawling like a caterpillar toward the trend line.
A rapid price movement towards the trend line, on the other hand, could result in a successful breakout.
Momentum can carry prices past the trend line and beyond when it moves at a rapid pace.
In this case, it is preferable to refrain from fading the breakout.
What is the best way to fade trend line breaks?
It’s actually quite straightforward. Simply enter when the price returns inside.
This allows you to play it safe and avoid jumping the gun. You don’t want to sell above or below a trend line only to discover that the breakout was genuine!
Let’s use the first chart example to highlight potential entry locations by zooming in a little.
Chart patterns are real price groupings that you may see with your own eyes. They are a vital aspect of technical analysis and can assist you in making decisions.
There are two basic patterns in which false breakouts occur:
- Head and Shoulders
- Double Top/Bottom
The head and shoulders chart pattern is one of the most difficult for inexperienced traders to recognize. However, with time and practice, this pattern can become a valuable asset in your trading armory.
A reversal is the head and shoulders pattern.
If it forms toward the end of an uptrend, it may indicate a negative reversal. If it forms toward the end of a downtrend, it may indicate a positive reversal.
Head and shoulders are well-known for producing fakeouts (false breakouts) and creating ideal conditions for fading breakouts.
False breakouts are typical with this pattern because many traders who detect it place their stop loss very close to the neckline.
Prices frequently rebound after a false breakout in the pattern.
When prices move against traders who sold the downside breakout or bought the upside breakout, their stops will be triggered.
This is frequently triggered by institutional traders who try to steal money from individual traders.
In a head and shoulders pattern, the first break is likely to be fake.
You can fade the breakout with a limit order back in the neckline, right above the high of the fakeout candle. You might set your target just below the high of the second shoulder or slightly above the low of the inverse pattern’s second shoulder.
The following pattern is the double top or double bottom.
Traders adore these patterns! Why do you inquire? They’re the simplest to spot, after all! When the price falls below the neckline, it indicates a potential trend reversal.
As a result, many traders put their entry orders very close to the neckline in case of a reversal.
The issue with these chart patterns is that many traders recognize them and place orders in similar positions.
This opens the door for institutional traders to steal money from ordinary people.
Similar to the head and shoulders pattern, you can place your order once the price has returned to its previous level in order to profit from the bounce. Stops can be placed slightly beyond the fakeout candle.
What market should I fade breakouts in?
Financial markets spend a lot of time bouncing back and forth between a range of prices, rarely deviating significantly from these highs and lows.
Price ranges are defined by a support and resistance level, and buyers and sellers constantly drive prices up and down within those boundaries.
In these range-bound circumstances, fading breakouts can be quite beneficial.
However, one side will finally take control, and a new trending stage will emerge.
Next Lesson: What is Fundamental Analysis?