Volume can also be used in order to confirm whether a breakout is real. Increased volume of trading can often occur with a breakout. Heavy volume indicates that traders are acting in the direction of the new trend and that there is power behind the penetration. This is so, as rising prices and rising volume are good signals of a healthy uptrend, while falling prices and rising volume are good signals of a healthy downtrend. All these methods, which we mentioned above, do have a significant drawback — they do not account for price volatility.
There are three most used means, with which to measure volatility — beta, standard deviation of a price and Average True Range. Betas use has decreased over the years, because the assumption it is a valid measure of risk has been questioned. However, it has a certain advantage, as it eliminates the market trend from the volatility calculation. Standard deviation of a price encompasses a series of prices over some time period in the past.
It has also become less useful as a breakout filter in time, because it includes the market trend in its evaluation. Average True Range ATR is related to the Average Range, which represents the average of the difference between each bars high and low during a certain period in the past. ATR is an average of the True Range bars close. The True Range is the greatest of :. As a price filter for confirmation of a breakout, when using a multiple of the ATR, the breakout level is adjusted in accordance with volatility. The ATR filter can expand and contract in time, following the change in price volatility.
This means there is a lesser chance for a fakeout to occur because of the increased price volatility. Very often a trader can use volume as a clue that a breakout is about to occur, because volume is tightly related with the trend itself. If trading volume rises with a trend, this will appear supportive of the trend itself.
When prices are fluctuating beneath a zone of resistance, for instance, and trading volume rises on every small up leg and declines on every small down leg, there is a chance that the price may break through the resistance zone. Prices may also indicate their next directional move. When we have a trading range, in case prices start to reverse upward and slightly above the lower boundary of the trading range and then reverse downward at the zone of resistance, this may signal that long position holders are becoming a little more aggressive with every minor correction.
If the tendency to have little rising lows comes with rising volume on each rally, the chance of a breakout through the zone of resistance increases. Skip to content « Pivot Points. Throwbacks and Pullbacks ».
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Breakouts This lesson will cover the following What is a breakout? In the red circle you see the exact location of the eventual breakout, which was to the upside. Notice the strong momentum on the breakout illustrated by multiple green marubozu candles. After the price breaks through the upper level of the triangle, it then retraces back in order to test the already broken resistance which is now considered a support area. This type of breakout pullback scenario is a very important confirmation signal in breakout trading, which we will discuss later in the article as well.
For me it is a general rule that a candle wick beyond a psychological area is not a breakout. I consider a real breakout to occur only in situations when the price of the pair closes the candle beyond the level. This way we get a more reliable breakout signal, one which can be used to trigger a position in the respective direction.
Have a look at the image below:. Again, we have a descending triangle with an upper resistance area and a lower support area. I have marked these with the blue rectangles. Notice the way the rectangles contain the bottoms of the price. The lower rectangle is located according to the first and the second bottom of the triangle. The upper rectangle contains all the tops of the price, except one candle which is pin bar style rejection candle.
This is our first fake breakout.
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We have only a candlewick going above the resistance area. However the candle does not close with its full body above the resistance area. For this reason we disregard this breakout signal and we would classify it as a false breakout. We get a second fake breakout afterwards. The last bottom of the price goes below the support area with its candle wick.
The candle is also a Pin Bar formation , also called a hammer pattern, and bounces strongly off the support zone. Again, since we have no candle closing below the support area, we would disregard this as a breakout signal. The Pin Bar subsequently pushes prices higher and five periods later we have a candle closing above the resistance area. This is our valid breakout signal. Notice that the breakout candle is a strong Marabozu candle, which further confirms that this would be a reliable breakout signal.
Breakout Trading Strategy Used by Professional Traders
Actually, it is not enough only to see the price breaking through a certain level in order to take a position in the respective direction. Though you can certainly initiate a trade after the initial candle close beyond the breakout point, there are better entry techniques in my opinion. They do require more patience on the part of the trader, and do not always materialize. But keep in mind, we are looking to trade the highest probability breakout trades, and not just every setup that comes around. Therefore, I have prepared 4 steps for you, which will confirm a breakout and we will set certain rules for triggering a breakout trading position.
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The following example illustrates a bullish breakout:. Stage 1 : A breakout appears as in the examples above. We observe price increasing and eventually goes through a psychological resistance. The price closes a candle above the resistance and we identify the breakout. Stage 2: The price creates a top after the breakout. In this example, the increase continues for two more periods, and then starts to move downward.
This creates the top we need. Typically the top we are looking for will be a fractal formation, meaning that the highest high will have two bars to the left of it with lower highs and 2 bars to the right of with lower highs. The reverse would apply for a bottom. Stage 3: The price retraces back to the already broken resistance and tests it as a support. The decrease continues and the price tests the already broken resistance as a support.
When the price touches the broken resistance, it bounces upwards, implying that this is now a strong support area. Stage 4: The top after the breakout gets broken. After we see a candle closing above the top, which was settled after the breakout, we have a strong confirmation that the price might really continue in this direction. Such situations are extremely useful to trade. You could apply this 4 step breakout signal confirmation in order to trade range consolidations. These are situations, where you have a breakout in a chart pattern for example and you expect the price to move equal to the the size of the formation.
If you are not confident in reading pure price action as it relates to breakouts, then you could consider using an additional trading indicator to help. One powerful indicator that a trader could utilize for a breakout trading system is the Momentum Indicator. The Momentum Indicator consists of an area and a curved line which fluctuates in the area of the indicator. When the Momentum is moving upwards, it gives us a signal that the price is likely to follow this trend.
3 Forex Indicators to Help You Confirm a Breakout
If the Momentum is moving downwards, this hints that the price is likely to decrease too. Also, extremely high readings in the Momentum Indicator suggest that the uptrend is likely to continue. At the same time, extremely low readings in the Momentum Indicator are inferring that the current bearish trend is likely to expand. I believe the optimal way to use the Momentum Indicator is for spotting divergences.
We have a bullish divergence when the price is moving downwards and the Momentum Indicator is increasing. At the same time, we have a bearish divergence when the price is increasing and the Momentum Indicator is decreasing. The divergence is a good indication that the price is likely to reverse soon.