When was the last time you entered a trade and it immediately moved against you even though you felt confident the market was going to move in your favor? When was the last time you traded a breakout and got stopped out? I’m willing to bet you’ve experienced one or both of these things recently in your own trading, and I’m also willing to bet that me or one of my students probably took the opposite side of one of these trades that seemed to ‘fake you out’ of your position…
You see, false-breaks happen all the time in the markets; they are a result of the ‘herd mentality’ that causes people to buy the top of a move or sell the bottom. As price action traders, we are in a unique position to take advantage of false-breaks and of the weak ‘herd mentality’ that so many amateur traders possess.
I have made most of my money as a trader by using contrarian trading approaches like false-breaks and my proprietary fakey trading strategy. It is the power of contrarian trading and using false-break patterns and fakey setups that allows myself and other savvy price action traders to profit from other traders’ misfortunes. This may sound a little harsh, but it’s the reality of trading that the majority of traders lose money, informed and skilled traders make money, and the ‘pigs get slaughtered’, as the saying goes. I hope there are light bulbs going off in your head now, because this article is all about contrarian thinking, false-breaks, and how to take advantage of the ‘herd mentality’ that causes so many traders to enter right when the market is about to change direction…
So what exactly is a false-break?
I thought you’d never ask! Joking, I know you are probably thinking that right now, so here you go…
A false-break can be defined as a ‘deception’ by the market; a test of a level that results in a break of that level but the market then retracts and does not sustain itself above or below that level. In other words, the market does not close outside of the level being tested; rather it leaves behind a false-break of it. These false-breaks are huge pieces of evidence for impending market direction, and we need to learn to use them to our advantage instead of becoming their victim.
Here is a visual example of a false-break of a key market level:
Essentially, a false-break can be thought of as a contrarian move that ‘sucks’ the over-committed side of the market out. The concept is to wait for the price movement to clearly show that a market has committed to one side of a trade and that they would be ‘forced’ to liquidate their position(s) on a strong reversal in the other direction. Typically, we see these scenarios unfold as a trending market becomes extended and all the amateurs jump in right before the counter-trend retrace, or at key support and resistance levels or at consolidation breakout scenarios.
The herd mentality causes traders to enter the market typically only when it ‘feels’ safe. However, this is the deception; trading off feeling and emotion is exactly why most traders lose money in the markets. Many traders become deceived because the market looks very strong or very weak, so they think it’s a no-brainer to just jump in with that momentum. However, the truth of the matter is that markets ebb and flow and they never move in a straight line for very long. This is known as “reversion to the mean” and it’s something I expand on significantly in my advanced Forex trading course.
We really have to use logic and counter-intuitive or ‘contrarian’ thinking to profit off of the weak-minded herd mentality that dominates most traders’ minds. This is why it’s very important to remain disciplined in the area of trading false-breaks, rejections and failures, and why I love trading them so much.
Types of False Breaks
1. Classic Bull and Bear traps at key market levels
A bull or bar trap is typically a 1 to 4 bar pattern that is defined by a false-break of a key market level. These false-breaks occur after large directional moves and as a market approaches a key level. Most traders tend to think a level will break just because a market has approached it aggressively, they then buy or sell the breakout and then many times the market will ‘fake them out’ and form a bull or bear trap.
A bull trap forms after a move higher, the amateurs who were on the sidelines watching a recent strong move unfold cannot take the temptation anymore, and they jump in just above or at a key resistance level since they feel confident the market now has the momentum to break above it. The market then breaks slightly above the level and fills all breakout orders, and then falls lower as the big boys come in and push the market lower, leaving the amateurs ‘trapped’ in a losing long position.
2. False-break of consolidation
False breaks of consolidation or trading ranges are very common. It’s easy to fall into the trap of thinking a trading range is going to breakout, only to see it reverse back into the body of the range. The best way to avoid this trap is to simply wait until there is a clear close outside of the trading range on the daily chart, and then you can begin to look for price action trading signals in the direction of the breakout.
Success in Forex = Learning + Practicing + Update Knowledge
FAQs
How can you identify false breakouts in chart patterns?
- Use confirmation indicators.
- Wait for the candle close.
- Look for retests and follow-throughs.
- Use multiple time frames.
- Use a stop-loss and a risk-reward ratio.
- Here's what else to consider.
The Fakey Pattern (Inside Bar False Break Out)
When price initially breaks out from the inside bar pattern but then quickly reverses, creating a false-break, and closes back within the range of the mother bar or inside bar, we have a fakey pattern. So, think of it like this: Inside Bar + False-Breakout = Fakey pattern.
How to avoid false breakouts trading? ›
The best way to be sure you don't get caught in a false-breakout from a trading range is to simply wait for price to close outside of the range for two days or more. If this happens, there's a good chance the range is finished and price is then going to start trending again.
Does breakout strategy work? ›
The reason breakouts are such an important trading strategy is because these setups are the starting point for future volatility increases, large price swings and, in many circ*mstances, major price trends. Breakouts occur in all types of market environments.
What is the most accurate breakout indicator? ›
The 3+1 Best (and Reliable) Indicators to Spot a Breakout
- Relative Strength Index (RSI)
- Moving averages.
- MACD.
- Volume.
Inside bars are perhaps the most 'classic' price action breakout strategy because they show a breakout from the consolidation of the inside bar setup. On a lower time frame such as a 1 hour chart, a daily chart inside bar will look take the form of a consolidation range, sometimes a triangular range.
Which trading strategy is most accurate? ›
Trend trading strategy. This strategy describes when a trader uses technical analysis to define a trend, and only enters trades in the direction of the pre-determined trend. The above is a famous trading motto and one of the most accurate in the markets.
What strategy do most traders use? ›
Top 10 Most Popular Trading Strategies
- Trading Strategy #1 – Buy and Hold. ...
- Trading Strategy #2 – Value Investing. ...
- Trading Strategy #3 – Swing Trading. ...
- Trading Strategy #4 – Momentum Trading. ...
- Trading Strategy #5 – Scalping. ...
- Trading Strategy #6 – Day Trading. ...
- Trading Strategy #7 – Positions Trading.
One of the ways beginners can implement the most profitable trading strategies effectively is by embracing the buy-and-hold strategy. This involves researching companies with solid fundamentals and stable earnings, then holding their stocks for a long time without being swayed by short-term market fluctuations.
What is the number one mistake traders make? ›
Studies show that the number one mistake that losing traders make is not getting the balance right between risk and reward. Many let a losing trade continue in the hope that the market will reverse and turn that loss into a profit.
The logic is that the price may continue moving in that direction after the breakout occurs. Other traders watch for false breakouts, and then trade in the opposite direction of the breakout. This is because they believe that if the breakout failed, the price may continue moving back in the other direction.
How to find fake breakouts in TradingView? ›
A false breakout is when the price temporarily moves above or below a key support or resistance level, but then later retreats back to the same side as it started. The “False Breakout” indicator reveals false breakouts in comparison to the previous candle.
What is the success rate of breakout trading? ›
Usually, traders use stop orders to enter such breakouts. Check the example below. Traders can catch a big move without even being at the desk. Although, depending on your stop-loss tactic, the win rate tends to be around 30% or lower.
How to trade breakouts like a pro? ›
Essential steps of a breakout trading strategy:
- Find a market trapped between a support and resistance. (Usually a trading range type pattern like a triangle or channel.)
- Wait for the market to break beyond the support or the resistance.
- Enter the market as volatility surges after the break.
One of the simplest ways to identify a false breakout is to make a note of how long it lasts. Because failed breaks are fleeting, watching your chosen asset for a while is often an effective way to tell if a breakout is genuine or not.
How can you tell a breakout from a fakeout? ›
Lesson summary
- If a price pushes through a support or resistance level aggressively - that's a breakout.
- If the price passes through support or resistance, only to reverse back shortly after - that's a fakeout.
They are:
- Price should trend up leading to the start of the pattern (if it trends downward, it's a broadening bottom).
- The shape of the pattern should resemble a megaphone with the smaller end toward the left, wider to the right.
- Price follows two diverging trendlines, one along the peaks and another along the valleys.
Breakout stocks often have a sudden surge in trading volume, which may indicate growing investor interest. Additionally, keep an eye out for stocks that are breaking through key resistance levels or forming bullish chart patterns, such as the cup-and-handle, ascending triangles or flag patterns.
How to identify true breakout? ›
Real breakouts often feature a quick retest before further advancement. Lower timeframes also indicate early signs of price reversal. Candle closures confirm authenticity. Assess the market environment; bearish settings raise false breakout odds, while bull markets support successful breakouts.
Essentially, a false-break can be thought of as a contrarian move that ‘sucks’ the over-committed side of the market out. The concept is to wait for the price movement to clearly show that a market has committed to one side of a trade and that they would be ‘forced’ to liquidate their position(s) on a strong reversal in the other direction. Typically, we see these scenarios unfold as a trending market becomes extended and all the amateurs jump in right before the counter-trend retrace, or at key support and resistance levels or at consolidation breakout scenarios.
