Timing is everything in Forex trade. The major support and resistance levels are authenticated, checked and watched out for regularly in hopes of a breakout that indicates a profitable trade trend. However, all breakouts do not necessarily contribute to profitable price trends. Fake breakouts, also referred to as false breakouts, are misleading actions that entice traders to enter the market, only to witness the price reversal unexpectedly.
Falling prey to such incidents can be damaging, particularly for rookies in Forex trade. Familiarization with what constitutes fake breakouts and their identification using trustworthy trade platforms that help to improve your trading accuracy and risk management.
Fake Breakout Concept in Forex
A false breakout happens when the stock breaks out above the resistance level or below the support level, only to fail, meaning it cannot move along this new trend. The general trend is, therefore, reversed. Key elements in fake breakouts are:
- Sudden Reversal: The price moves back into the original range.
- Low Volume of Trading: A genuine breakout is accompanied by a significant increase in volume.
- “Market Manipulation”: Large traders or liquidity providers can cause “fake breakouts” in an attempt to “shake out” retail traders.
Reasons Why Traders Experience Fake Breakouts
When looking for more effective ways to avoid fake breakouts, here are some examples of how they occur:
- The broker/institution uses stop-hunting techniques to trigger recent built-up barriers, allowing the market to continue in the direction of the trend after hitting all of the stop-loss orders on the way up.
- The market does not have enough trade volume during the off-market hours or during holidays, therefore the market has a much greater possibility of experiencing a fake breakout.
- Unexpected news releases will create sudden spikes to the downside, followed by rapidly falling back to the original price.
How to Identify the Fake Breakout?
To identify a fake breakout, traders must be able to spot several signs that indicate an impending breakout. The best way to spot a fake breakout is to check for signs of high trade volume.
If you’re going to be trading, wait for the close of the first/second candle that closes above/below the previous price range (breakout point) before entering the market. When trading, it is also a good idea to look at several different time frames before deciding on which one to initiate a trade.
If price has a new high with the longest wick at the high point, there is a significant likelihood of a reversal at that point.
Signs which may indicate a false breakout
Detecting a possible fake breakout before entering into a trade can save you from incurring unnecessary losses. Although breakouts have tremendous opportunities for traders, there are some indications that might reveal that the breakout is not an actual breakout. The following are the warning signals that need to be recognized:
Low Volume
A true breakout would normally come with high volumes of trade, reflecting high market interest. Lack of volumes in a breakout indicates that not many people are behind the market, and thus the trend will easily reverse.
How to use this? Compare the current breakout volume with the average volume of the several preceding periods. If the break-out happens with less-than-average volume, one needs to be very cautious about initiating the trade.
Volume indicators such as On-Balance Volume (OBV) or Volume Profile can be used to verify the strength of the price action.
Long Wick or Rejection Candle
Candlestick patterns can often indicate a trader’s indecision or rejection at important levels. Long Wick’s, or rejection candles, are produced when price briefly penetrates support or resistance levels in either direction, and then immediately returns back.
A strong rejection candle with a very long wick is often used to signal that the market has yet to positively accept the breakout. When to Use Long Wick or Rejection Candles? If price produces a long wick or rejection candle, do not enter a trade at that time. Wait for the next candle to confirm the breakout direction.
Weak Momentum
When to Use Weak Momentum? Be on the lookout for MACD crossover in the breakout direction. Check to see if the RSI is moving in the same direction as the breakout, and not overbought/oversold in either direction. Weak or Conflicting Momentum Indicators may have a higher potential for false breakouts.
Price Action Features for False Breakouts
False breakouts will have the following patterns:
Patterns
| Patterns | Details |
|---|---|
| Reversal Candles | Long wicks, pin bars, or dojis. |
| Failed Closes | Price closes back inside the previous range. |
| Volatility Spike, Then Reversal | Rapid spike and subsequent pullback. |
How to Trade Breakouts?
Trading actual breakouts effectively:
Steps of Trading Breakouts
| Steps of Trading Breakouts | Explanation |
|---|---|
| Wait for Confirmation | Allow the breakout candle to close beyond the level. |
| Set Entry Orders Above/Below the Breakout Zone | Prevent those early entries. |
| Use Stop-Loss Orders Successfully | Set them just inside the boundaries of the previous range to limit risk. |
| Target Realistic Profit Levels | Measure the next support and resistance levels for possible exits. |
Trade Breakouts with a Buildup
Search for the consolidation or build-up at support or resistance prior to a breakout. In most cases, extended periods of consolidation precede true breakouts. Make trades after identifying that there has been a strong movement out of the build-up zone.
Once price reclaims the support level, traders enter a buy position with expectations of a move upward as trapped sellers are exited.
How to Trade a False Breakout?
When it comes to trading false breakouts, beginner traders typically avoid them as opposed to advanced traders who will utilize them as potential places to open a position. In most cases, a false neckline break will typically result in increased momentum in the inverse direction to create higher-probability reversals.
The following sections are intended to provide an overview of the most common methods utilized by traders to trade false breakouts as outlined below.
Long a Failed Downside Breakout
A failed downside breakout occurs when the price has decisively broken below a support level but immediately reverses course and moves back above the latter. This usually takes place when one cannot succeed in pushing lower by sellers. How do traders use it?
- Price breaks below support, with sell orders being triggered.
- Lacking follow-through, price rebounds sharply.
This forces sellers to exit their positions, feeding upward momentum. Traders go long (buy) following price confirmation of it.
Sell a Failed Breakout on the Upside
The definition of a failed upside breakout is that the price for a given instrument has broken through a resistance level, but was unable to keep that level and then fell back below it shortly after gaining support at the Resistance Price Level.
The result of this is that the market then puts further downward pressure on the previously broken-out level leading to additional upward and downward pressure by the buyers who were caught in the wrong side of the market.
The majority of the time when the breakout buyers decide to take their profit on the upside, they no longer have entry opportunities at a greater profit than what they originally purchased the stock or instrument. Best confirmation signals of a failed upside breakout include both:
1) Long Upper Wicks, i.e., Rejection Candles.
2) Bearish Engulfing Patterns
3) Weak Volume During Breakouts.
The failed upside breakouts would indicate that a seller has a higher level of support as compared to past breakouts which in turn creates the potential for faster and higher levels of reversals on an overall trend as well as additional momentum on the failed upside breakouts as compared to pullbacks.
Verify with Price Action or Indicators
For decades now trading on untrue breakouts without verification can be dangerous. Successful traders do not make educated guesses; they wait until the evidence that the breakout failed appears. Confirming the price action consists of:
- Pin bars indicating strong rejection
- Engulfing Candles Indicating a Momentum
- Multiple closes back within the previous range
Confirmation of the indicator includes:
- RSI divergence (price makes new high/low, but RSI does not)
- MACD crossover against the trend of the breakout
- Falling Volume in the breakout attempt
Always avoid trading on a false breakout due to the initial spike. Confirmation will save you from getting in too early.
Fakeouts Vs True Breakouts, What’s The Difference?
Fake Breakout vs True Breakout
| Feature | Fake Breakout | True Breakout |
|---|---|---|
| Volume | Low or irregular | High and steady |
| Price Retention | Returns within former range | Consolidates in breakout direction |
| Confirmation Candles | Lacks follow-through | Multiple candles confirm trend |
| Momentum | Weak | Strong |
| Trading Opportunity | Risky, requires caution | Higher probability of profit |
How to Program the Fakeout Logic into a Strategy
- Protecting your trading strategy from fakeouts involves
- Only enter a trade after confirmation, such as a retest or multitimeframe validation.
- Use a stop-loss strategy that considers the possibility of fake spikes.
- Combine trend indicators, volume, and price-action analysis for stronger breakout validation.
Examples of False Breakouts
Market behavior is the best way to understand what is meant by ‘false breakouts’ and therefore a trader can see patterns of false breakouts they need to look for in the Forex market by looking at a few examples.
The following are the most common false breakout examples in Forex with a clear and easy to follow explanation.
Example 1, False Breakout Above Resistance
As a trader, you will watch the approach of the price towards an identified resistance level that multiple traders are observing and ready for. Once the price has moved above the resistance level, you will see multiple traders buying in anticipation of a continuing upward movement (which includes buy orders and stop-losses), yet the lack of volume and market momentum for this break indicates it will not maintain itself.
The price will most likely come back down to the support level from where the breakout was initiated. What Makes it a False Breakout:
- A long upper wick on the breakout candle
- An inability to maintain a position above the resistance level
- The inability of volume to support a continuation.
Traders with experience will wait until the candle closes beneath the resistance and place their sell order targeting the middle of the previous trading range. What all this means is you want to take immediate action once you see the breakout candle has closed back within the previous range.
Example 2: False Breakout Below Support
Price breaks below a major level of support, which persuades traders that a bearish trend has begun. Sell orders begin to pour in, but buyers soon become aggressive and drive the price back above support. Why it’s false:
- Strong rejection as depicted by long lower wick
- Price closes back inside the prior range
- Momentum indicators do not confirm the breakdown.
Once price reclaims the support level, traders enter a buy position with expectations of a move upward as trapped sellers are exited.
Example 3: News-Driven False Breakout
A high-impact news release sends the price sharply higher to break a key level. After a few minutes, the market stabilizes and the price falls back into its previous structure. Why it’s false:
- Sudden volatility without structure
- No sustained follow-through after the news
- Market correction after emotion dies away
Disciplined traders avoid chasing the initial spike but instead wait for price to return inside the range and trade the reversal upon confirmation.
Example 4: False Breakout in a Low-Liquidity Market
Price moves beyond the areas of support and resistance during non-active hours of trading due to low liquidity. The movement initially seems convincing but, because there is no liquidity in the market when the price comes back into a more normal level, it will fail. Why It’s False:
- The breakout occurs during a low-volume market period.
- Most of the major market participants are not active.
- After the breakout fails, the price will retrace back to the established range.
Traders are reluctant to trade breakouts in low-volume markets. They wait for confirmation of the breakout during the active period of trading.
Tools and Techniques to Prevent Fake Breakouts
Effectively bypassing false breakouts often needs the implementation of several technical analysis techniques. Here are the best ways, explained in detail.
Trend Indicators
Some of the commonly used trend indicators include:
- Moving Averages (MA)
- MACD (Moving Average Convergence Divergence)
- Support and Resistance Zones (As Opposed to Exact Support and Resistance Lines):
- Average True Range (ATR): ATR Represents The Average Daily Movement Of A Currency Pair.
Wait for Retests
That is patience being the best friend that the day trader could possibly have in the case of breakouts. Frequently, what looks like a genuine breakout will come back and test the actual support or resistance level that has just been.
Entry Strategy: Instead of entering a trade on the initial breakout, it is better to enter it on the retest confirmation. It helps eliminate fake ranges. The retest gives better odds of success for entry.
The Importance of Avoiding False Breakouts to the Study of
- Prevents unnecessary losses and stop-outs.
- Raises the chances of profitable trades.
- Assists in optimal capital allocation.
- Increases confidence in trading choices.
Risk Management in False Breakouts
Managing risk can prove vital in trading breakouts:
- Place tight stop-losses just inside the breakout zone.
- Leverage volatile sessions carefully.
False Breakout Pattern Trading Tips
Consider these tips:
- Rather, trade on the confirmation, not the initial pop.
- Wait for the price to test the level broken.
- Employ multiple indicators such as volume, trend, and momentum for cross-validation purposes.
- Trading when news spikes should be avoided without volatility strategies.
The way STP Trading Assists Traders in Avoiding False Breakouts
A trusted trading platform will help in overcoming the problem of fake breakouts. This will result in increased profits. STP Trading provides:
- Direct Market Access: Trade without unnecessary dealers,thus less slippage risked.
- Advanced Charting Tools like: Breakout analysis with multiple time frames and providing free signals with advanced charting tools along with STP Trading indicators.
- Real-Time analysis and Market Data: An accurate price feed enables the identification of genuine breakout moves.
- Risk Management Tools: Set stop loss, take profit, and trailing stops.
- Low Spreads and Fast Execution: This feature helps to ensure that the breakout trades are conducted instantly.
Through the integration of technical knowledge and the characteristics that STP Trading offers, it becomes easy to minimize the chances of being misled by the false breakout.
Profit Comes from Patience, Not the First Move
Fake breakouts will happen in Forex trading, but they should not be a problem for your trading plans. There are signs that a fake breakout is imminent, which can be avoided by trading on a valid platform, you can trade with confidence and secure your funds.
Leverage professional level tools, fast execution, and accurate market information by signing up with STP Trading and elevate your Forex trading experience.
FAQ
Is there any currency pair that gives rise to fake breakouts?
Fake breakouts can happen in all currency pairs; however they are more likely to occur in divisions of a currency that are either relatively illiquid or have moderate levels of volatility.
Do all timeframes give rise to an increased number of fake breakouts?
Timeframes of 1 Minute or 5 minutes will have a higher likelihood of seeing a fake breakout because of the smaller amount of activity that occurs during those time periods and the frequent temporary price spikes that occur in those divisions of the market.
Do unexpected news events trigger fake breakouts?
Yes, there are often temporary spikes in price action following the announcement of new information that when the market has fully digested the information have a tendency to retrace back to their previous level.
Is it advisable to trade immediately following a breakout?
It is advisable to wait for confirmation of the breakout or to retest the level; thus it is risky to jump into a trade immediately following a breakout.
Do all brokers have tools to help traders avoid fake breakouts?
Most brokers don’t have advanced charting tools or tools for risk management; however, brokers have made it their business to provide these sorts of tools to help traders use advanced trading strategies to maximize profits.
Are automated trading systems capable of identifying fake breakouts?
Automated trading systems can identify fake breakouts using algorithms, however, there is no 100% fail-proof system; therefore using a combination of technical analysis and one’s brokerage platform will increase the chances of being able to identify fake breakouts.
