How to Develop a Breakout Strategy

23break3290913 One of the most favorite trading strategies deployed by spread betting experts is the breakout. This is because market price must generate a large quality of energy in order to breakout from a restricted consolidation structure. Whenever this task is accomplished, then the ensuing momentum is usually so great that it is capable of propelling price in its new direction for some extended time.

Entry locations for new spread bets are also simple to identify using breakouts. Basically, as price would have been advancing within a restricted range, limited by a resistance level or ceiling and a support or floor, then you just need to wait for it to pierce either of these two levels before executing a spread bet in the direction of the breakout.

 

Trading Breakouts

A breakout strategy will now be presented which will also help introduce you to some of the main concepts behind this type of trading. Normally, price moves quite extensively in one direction before it settles into a consolidation pattern. As such, you must first identify such formations on the trading charts of any asset of interest. This task can be readily achieved because these patterns will possess an upper trendline, denoting a resistance level, and a lower one representing support. The distance between these two limits is normally quite small. The following chart illustrates these conditions.

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One such pattern is the flag which consists of its two trendlines in parallel usually pointing in the opposite direction to the prevalent trend. The second is the pennant which is formed by its trendlines converging to a point. This structure, unlike the flag, is normally horizontal. As price becomes so restricted inside these consolidation patterns, it builds up extensive pent-up energy. As such, you just then have to wait for price to decisively pierce one of the trendlines of the prevailing consolidation pattern. When this happens, you could then be tempted to exploit the breakout by activating a new spread bet immediately since the potential profit could be quite substantial.

However, you are advised not to support such practices. Instead, you must adopt patience in order to determine if the breakout is real or whether it will convert into a fakeout. You can detect a fakeout by observing if the initial move fizzles out and then price re-enters the original consolidation pattern. One fact that will help you achieve this objective is to appreciate that during a bullish breakout the original resistance becomes the new support.

So effectively, you can determine a fakeout if the price plunges below the new support. The converse is also true for a bearish breakout i.e. the old support becomes the new resistance. By simply waiting for the initial breakout to successfully form completely without reverting into a fakeout will enable you to identify quality trading opportunities for new spread bets possessing high profit potential at minimum risk. As such, you must always remember that authentic breakouts will bounce sharply against a consolidation pattern before continuing in their initial direction.

You definitely must utilize a well-tested money management strategy to safeguard your equity as well as augmenting your ability of achieving success whenever you implement breakout trading. Essentially, this fact implies you must never wager more than 2% of your available balance on any individual spread bet. You may assess that by doing so that you will require a substantial period of time in order to amass any worthwhile profits. However, this analysis would be faulty because the returns from a sequence of consecutive wins would increase your balance exponentially.

In addition, you are also well advised to calculate the expectancy value and win-to-loss ratio of your break-out strategy using a demo account before going live. Performing such actions thoroughly, in advance, will provide you with increased confidence before you start trading the spread betting markets for real.

 

Breakout Problems

However, the main problem that you will face using a breakout strategy is that a breakout can often transform into a fakeout, which could eventually stopped-out your bets. Such an event happens whenever price retracts so that it re-enters the old consolidation pattern. Under such circumstances, price could reverse even further in the opposite direction to the original breakout. A fakeout or false breakout is demonstrated by the next diagram.

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Many analysts have tried to determine exactly why fakeouts occur because if they were successful in accomplishing this task, they could use this information to increase the profitability of their breakout strategies. Some theories attribute the creation of fakeouts to technical analysis failing at the point of the breakout. However, such events are bound to happen sometimes because the spread betting markets are not predictive in nature. As such, the best that you can hope to achieve is to determine the probabilities of particular actions occurring. Consequently, the generation of fakeouts for a percentage of the time supports this viewpoint.

Other theorists claim that fakeouts are caused by large institutional players, such as banks, creating them deliberately in order to stop out smaller traders. Although there is much speculation that this could be true, there is still no real evidence proving the validity of this concept. Nevertheless, fakeouts are events that occur so frequently that some investors have even designed trading strategies in order to profit from them. However, if you do attempt to trade fakeouts, then you must appreciate that you will be trading against the trend, which is a dangerous practice.

 

Trading Fakeouts

You can attempt to profit from trading fakeouts by opening spread bets in the opposite direction to the primary market direction. This idea is applicable to whether the price is trading a sloping or horizontal channel. You first need to locate the resistance and support levels of a consolidation pattern and then monitor it using the applicable trading chart. For example, to determine a fakeout during a bullish breakout, watch closely for the price to first penetrate the resistance level but then reverse direction and close back beneath it. Activate a short spread bet at that point

If, however, price continues to drop lower very quickly, you should then wait for a corrective rally to complete before activating your bet. Under such conditions, you should place your stop-loss order above the highest level of the fakeout. In addition, you should locate a profit-target order using the reward-to-risk ratio of your trading strategy.

However, the biggest concern about trading fakeouts is that you will, in effect, be trading against the trend. Nevertheless, you can provide your equity with protection against such adverse conditions by adopting a good money management policy. Are there any opportunities whereby you could trade fakeouts in the direction of the trend, you may ask? Yes, there are.

For instance, assume that the price has been trading within a bullish trend for some extensive time. The bottom trendline of the channel is acting as a support level. Under these conditions, price often drops to pierce beneath the support level. However, a fakeout can then occur by price breaking back above the old support line. Price could subsequently advance in the direction of the old trend for some distance. If you can detect such a sequence of price action then you should consider activating a long spread bet as soon as price re-enters the consolidation pattern.

Trading fakeouts successfully requires very good timing which is not always easy to accomplish. This is because of emotions, such as anxiety and nervousness, can influence your judgment and logic. Fortunately, there are methods that you can use to minimize these effects such as the following:

1. Wait for the current time-frame to complete during which a breakout occurred. After assessing the situation at the start of the subsequent period, determine the viability of activating a new spread bet.

2. You can use technical indicators, such as the Fibonacci retracements to help you identify the best entry locations for new spread bets.

By successfully mastering the above skills, you can then incorporate both breakout and fakeout strategies into your arsenal of spread betting trading methods.

 

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