How to Correctly Trade Breakouts
Hello traders! Welcome to the Price Action Course and the sixth module, ‘Price Action Strategies.’ In this video I’m going to teach you how to correctly and profitably trade breakouts. I know we talked about breakouts before in this course and in other courses here at investoo.com. But in this course I’m going to teach you how to correctly assess that a breakout is in play. Not only are we going to look for a candle that closes above or below the range that we are looking at or outside the structure of the market that we are looking at but we are going to look for rejections on the opposite side. Let’s go through this lesson so I can teach you how to spot these rejection candles. Trading breakouts is very profitable and truly a price action base strategy. Whether we are talking about a triangle, a wage, a flag, or a breakup of resistance or below support, the one thing we must understand is that it’s all about momo. And we are talking about momentum here because it falls in the realm of order flow analysis.
Let me just picture this for you guys. Let’s imagine that we’re in triangle and price is trading inside this triangle bouncing off the descending support and ascending resistance and when price breaks outside of this triangle, price action is going to invite a lot of buyers or sellers either if the breakout is to the upside or the downside. And that is going to create momentum. The momentum comes from when a price structure breaks. For example, a breakup of a strong resistance zone is going to invite massive buyers into the market just like we said before. Here’s what’s important about breakouts. Always look for a rejection candle as confirmation, okay? And here is how we are going to avoid losing money on a breakout trade or how we are going to improve our win rate on breakout trade.
Now let’s look at an example and let’s imagine that this is a support zone and price action has been testing it and rejecting it once and twice right here.
Now here we have a break below the support zone but the thing about this breakout is that one, we did not break below this low, which means that we did not make lower low and we were testing this range for a long time so trading that breakout or trading that candle that closes below the support zone is going to be an even 50/50 probability that price is going to go to the downside. Because we’re trading with price action, we have to read these rejection candles as strong rejection, once, twice, and look at these rejection candles and on the fourth one right here before we break to the downside. So this can mean that one, we have strong buyers that are trying to push price up and this candle could mean that we finally tired those buyers and we were able to close below, but it also can mean that this was just a push below from the bear market and buyers are going to pick it up, okay? Or it can be that this is just a stop run from long positions that have too tight of a stop loss. It can mean a lot of things and if we don’t have a confirmation candle or a confirmation that this is a true breakout, we are in no man’s land.
We are in a near 50/50, maybe a negative probability scenario here. So we are going to look for that rejection candle to the opposite side, meaning that if we break to the downside, we are going to look for that rejection candle to the upside and this is the candle that I’m talking about. You can see the price breaks with this support zone, then we close below the area of support and then we have a rejection candle of that area of support as resistance, now after that candle we are in a much better place for trading that breakout. Why? Because this means that price came… or that bears eventually pushed price down and were able to close below this area of heavy support where a lot of buyers were placed at and when we close here, buyers tried to push price up but the bear pressure was so strong that price closed at almost the same level as it opened, giving us a super strong rejection signal. And after that you can see that price continues to the downside. So whenever we have a breakout we are going to look for the rejection candle and we are going to trade that breakout.
If we don’t have that rejection candle, we are going to pass on the breakout and that is going to give us a better win percentage on our breakout tradings. And we are going to make a lot of money on the long term. And of course as we’re calculating targets, always measure the height of the structure and then extrapolate it to a breakout zone and this we already discussed in previous lessons. Now let’s go through a Euro/US dollar chart and let’s see if we can find a breakout that has a rejection candle as confirmation. Okay traders, so this is the Euro/US dollar four-hour chart and let’s talk about a… well, we have been on a very, very strong move to the downside so we are going to look for breakouts of previously tested areas of support, okay? So right here we have one, you can see that…. let me thicken this line for you so you can better see it.
And we have this area of support and remember that support is not just a line but an area. So we are going to use both the low of the candle’s body and we are also going to use the high of the range. Now you can see that we are in a very strong down, okay? Now let’s grab another right here and you can see that the move from this high to this low, or this resistance support zone is very strong. And actually the support zone is not only this low but also this low right here, so right here we are having an even better representation of the actual support zone. You can see the price tested this area, then tested these highs as resistance, then we have a huge rejection to the downside giving us a small rally, okay? And we are going to measure this range, okay? It’s an 85 pip range so it’s not such a small range, and right here after this rejection candle, you could have made 85 pips to the upside but we are not talking about this.
And then you can see that price was just testing this area to the inside of this range. Then we have a breakout and right here we have a breakout of this area and you can see that the candle closes at this spot right here. And this are the breakouts that we are not going to trade because we don’t have a rejection candle and of course at almost 125 pip candle, we are not going to take the trade… well, a 174 pip, we are not going to take the trade because the stop loss would be too big, but now let’s look for an actual breakout that we could have traded and the actual breakout that we could have traded comes right here. You can see that right here we have an area of support, okay? We have the low of this candle and we also have… let me just thicken this line a little bit because I like to see my levels, I like to have a very strong visual understanding of my levels, and right here we have the low of the range and you can see that this is what I’m talking about, okay?
We have this candle that closes to the downside, okay? But like the example that we saw in other lesson we have one, two, three, four, five strong rejections — well, six if you count this one — of the support zone. So right here, you can see buyers were encountered at these levels because they were buying the dip and buying the zone and buying the same area but we had a very strong bear-ish presence at these levels, and then this candle broke, okay? This candle broke with the support. Then we have a dodgy and then we have a rejection candle, which is this bullish candle to the upside, okay? When this candle closes, you can go short, because you have a rejection of this support zone as resistance and you can go short at the close of this candle and your stops should go above the area of previous support and now resistance. So we were just risking 30 pips for an actual target [inaudible 00:11:07] we would have used these lows as targets for a 82 pip target. So that is almost a 1:3 risk-to-reward ratio, and you can see that after this bullish… well it’s a bearish rejection at a resistance zone. We have another candle that has the same reaction to these levels. It rejects the levels before we start to go lower, and as always we use levels as our targets and you can see that right here, we actually made 90 pips on the trade for a 30 pip risk. So every time you have a breakout look for that rejection candle, and when you get the rejection candle just go with it because the setup is there.