Updated: June 17, 2021
Breakout strategies are classic for Forex and stock trading. They can be used effectively in any market. The basic idea is that the market moves from one point of market equilibrium to another. If the price consolidates within the range for a long time, the market accumulates interest. Therefore, we should expect a breakout in a certain direction as a result of a forceful market decision. The constant trading imbalance between buy/sell prices leads to the expansion of a trading range. While the market is looking for a new equilibrium point, we can get attractive trading opportunities.
How the strategy works
If the price is approaching and tests the defined level, there are two possible scenarios of the price behavior:
- breakout: the price moves beyond the level and holds there, then the quotes start moving further;
- reversal: the price bounces off the strong level, reverses and starts moving in the opposite direction.
The frequency of the tests indicates the strength of the support/resistance level. The more often the quotes approach the level and pullback, the stronger the barrier is. So, more efforts and stronger momentum are needed for the breakthrough. You can open a trade expecting a breakout when the support/resistance level has been tested several times. And the more pullbacks and failed attempts to break the barrier the price made, the further it can go after the breakout.
- Opening a ‘buy’ position
- You need to set a pending order to buy 2-3 points from the high of the previous trading day bar. Stop-loss should be placed 20 points from the expected entry point. This point will be your minimum expected profit. If the order is triggered, the trader will receive a profit of 20 points and the trade will be closed automatically.
- Opening a ‘sell’ position
- You need to place a pending order to sell. The distance should be 2-3 points from the low of the previous day candle. Place a stop-loss 20 points away from the opening level.
Pros and cons of the strategy
The advantages of this strategy are:
- This technique is suitable even for novice traders who are not well-versed in technical and graphical analysis yet. This strategy does not require special knowledge and skills and doesn’t take much time too.
- no need to monitor the trade. When using a breakout strategy, trading is carried out through pending orders, so the trader does not need to stay at the monitor and watch his trading.
- quick profit. Almost all strategies using the daily chart imply getting a profit in a few days. When trading the breakouts you can get the result within the trading day. Besides, you do not need to transfer your position to the next day and pay a commission to the broker.
However, this strategy also has its disadvantages:
- high risk of closing a trade by the stop-loss order. When market volatility decreases, the candlestick may not pass the predefined number of points
- small number of transactions. You can open only one trade per day for one financial instrument. You can trade only if one of the significant barriers was breached. This, in turn, further reduces the number of potential entry points.
To trade using the breakout strategy and generate steady profits, you need to catch the periods of market volatility. If the strategy is used correctly, even medium volatile assets will suffice.
The real trading effect can be seen on timeframes longer than H1. Scalpers can also take advantage of this strategy and trade on reversals or corrections.