Trading Breakouts and Measuring the Moves

Screen Shot 2014-06-17 at 11.12.19

Video Transcription:

Hello traders! Welcome to the Price Action Course and the fourth module, ‘Market Fractals.’ In this lesson we are going to learn a trading strategy based on pattern breakouts. This means that we are going to use everything we have learned so far, and we are going to use it all to profitably trade these breakouts. So let’s start with a little bit of history. Trading pattern breakouts is one of the oldest and simplest trading techniques and this is because it’s purely based on price action and the observation of price action and momentum. We don’t use any fancy indicators and we don’t use any trading system that took years of development.

Day traders use it all the time because they yield great results with minimum risk. And the reason they yield great results is because they have a very high probability of success if they are traded correctly. And this means whenever we have a breakout of a triangle, a wedge, a flag et cetera, the probability of success is high, meaning that the probability that price is going to continue on the same direction as the breakout is very high. The problem is that most traders don’t trade them correctly and they tend to get lost whenever they enter the trade and this means that their probability of success or their win ratio drops massively.

Trading Pattern Breakouts

In this lesson we are going to teach you where you are going to place your targets so the probability of success for every single time you trade a breakout is going to be high. Because these are momentum trades, we need to know when momentum is going to end for us to also get out at the high of a move before a correction. And here we are talking about day trades, maybe a trade that is going to last a couple of hours, maybe the entire day if we are trading the one-hour chart, and maybe a couple of minutes if we are trading the lower time frames. But in any case the higher you go on time frames, the higher the probability of the success of the setup is going to be higher because the higher we go, the stronger the patterns.

To measure a target, we are going to measure the inside of the pattern from the high of the pattern to low of the pattern. Then we are going to extrapolate the measurement to the breakout zone to have a perfect target. And the larger the pattern, the longer we are going to have to hold our trades. This means that, let’s say that we are trading the four-hour chart, then we have a triangle pattern that has been… price has been trading inside a triangle pattern for the last two days, and we are riding at the tip of the triangle where price is going to start to accelerate strongly to one side, meaning that it’s going to break out soon. When the breakout actually happens, it could mean that we are going to have to hold our position for the rest of the day. That also depends on the high of the actual pattern. But right now we are going to go to the same gold chart that we left behind on the last lesson to calculate the actual targets on all the breakouts we went through.

Screen Shot 2015-02-24 at 14.57.11

So here’s the gold chart that we looked at on the last lesson. And this is the first pattern that we looked at, which is a bull flag after this strong move to the upside, right after we broke with this down structure and then we tested it to go higher. So the first thing we are going to do is we are going to measure from the high to the low of the pattern. And as you can see we have 28, almost $29 move from high to low. So what we are going to do is we are going to… you can use the ruler or you can use a line, but what we are going to do is we are going to draw a line from high to low and then we are going to move it out to the breakout area. And as you can see, from this breakout to this high, we have a 28.60 move and this means that by putting our limit order here or our targets right here, we have hit the high of the move. You can see that from this high to this low, we have about $29 and when we calculate it from this breakout to right here, this area, you can see that we have almost $29, also 28.65 on the targets and 28.88 on the actual high to low. And you can see the target hits this area strongly and then fails to break above our targeted area. This means that we encounter here a lot of profit taking, okay? This doesn’t mean that we got sellers here. This means that we’ve got a lot of profit taking here and this didn’t allow the price to close above and you can see that then we move down to this area right here.

Now, the second pattern that we are going to watch is this triangle right here and you can see that from high to low, we have $17.25, and let’s go and calculate from the breakout to this high. Now, right here we have $17.25, okay? So again our target zone would have to be around this level right here, okay? You can see that price actually went and made this high, and then dropped drastically to this lows before hitting our targets. And remember that sometimes you are going to see this; you are going to see price barely hitting, stopping very close to your target areas. But if plan your trade and you trade your plan, you have to wait for your targets to be hit. Now we also want to talk about stop-loss orders. In this case our stop-loss order should go right here below the low of the pattern, okay? Below the last low, and this is because if price breaks to the upside and breaks with this low, this pattern is no longer in play and of course the up structure is no longer in play because we will be making lower lows and this pattern would have broken to the downside and this means that you are actually risking $10 per lot to make 17.25 per lot. And this is almost a 1:2 risk-to-reward ratio which is fine with me and with everybody.

The third pattern we looked at is this also triangle formation, looks more like a wedge formation from high to low, we have $19.20. So our target should be right here at $19.20. Let’s see and $19.20 should be around here, okay? Now you can see that we have this horizontal line which was the last important high just before we broke with the down structure. So if your targets… remember that this is a price action course, so if your targets are highly above this area, you could put your targets right at the designated or the measured area or you can put your targets right at this area of strong resistance, okay? And that is up to you. If you want to be safer, you can put it right at the area of strong resistance. And if we calculate it to the previous high, you can see that we have a better than 1:1 risk-to-reward ratio on this trade tool. Now this is the four-hour chart and you can see that the most of the trades last from two candles to three, four candles. Well, from two candles to three, four candles exactly because this is a four-hour chart. And what I want to do right now is I want to show you bigger formations that you might want to trade, meaning that if you are looking to trade or if you are looking to use this trading technique to swing trade, you can also use it. And I’m going to show you this on the US Dollar/Japanese Yen. So let’s go to the US Dollar/Japanese Yen.

Screen Shot 2015-02-24 at 14.57.24

This is the four-hour chart of the US Dollar/Japanese Yen, and for a quickly pattern breakout, you can see that price right here is making low highs, price tested this standard resistance once, twice, failed it the third time and then broke to the upside. You also can see that we are making higher lows, okay? From this lows right here to this high right here, okay? You can see that it was tested once, twice before we moved to these levels. And then we tested it once again, twice again before we broke. And if we want to be correct about the true breakout zone of these patterns, remember that whenever we have a fake-out you can adjust or you’ll need to adjust the trend lines to the actual high of the move, because when you adjust it, you can see that price breaks it, then retests it and then moves all the way up here. Now, from this low to this high, we have 520 pips, so we are going to measure from this breakout zone to this highs right here — 520 pips. So our target area of this breakout should have been right here, and if we put our ruler right at the spot, you can see that you would have had to hold that trade for 13 days before it hit your target zone.

This is how pattern breakout can also be profitable for swing traders, but remember that if you are going to swing trade and if you are going to wait for these patterns to break on the higher time frames, you need to plan your trade and trade your plan, meaning that if you are waiting for this triangle breakout, you have to wait for the targets to be hit, and the cool thing about this is that your stop-loss would have to go right here below this spike low, meaning that you would have had around 165 pip stop for a 520 pip play profit, meaning that would be a better than 1:3 risk-to-reward ratio. So this is actually how you calculate targets, how you wait for the breakout and where you put your stop-losses, okay? And be aware that if you use too tight of a stop-loss, you are certainly sometimes going to be taken out on a loss. And this is what we said at the beginning of the lesson when we said that sometimes traders don’t trade these breakouts properly so they don’t have such a big win ratio when it comes to trading them. Because let’s say that they wait for these breakout to happen and they put their stop-loss right here below the previous candle, they are going to be taken out on a loss when price tests this area.

And if they use this area stop-loss, it’s wrong because even though price goes to the downside and against them for a little while, their trade idea is still valid because we are still above the standard resistance of the triangle and we have not broken with this lows, meaning that the long idea is still on. And if you put your stops here and 13 days later you open your chart and you see that your targets got hit and then some, you are going to [inaudible 00:14:18]. So always follow these rules, wait for the breakout to happen and trade safely.

Comments are closed.