False Breaks are Opportunities – Example with EUR/USD
Buy high and sell much higher, or sell low and cover much lower. Such phrases are the bread and butter of breakout traders. However, this can end in a false break too often.
A false break is quite frustrating for traders that are stalking a breakout. They enter the trade in the direction of the breakout only to see the pair return back to the range, burning their money.It doesn’t have to be that way. A false breakout can be an excellent trading opportunity, if you have the patience.
A false break is a small move, that could be followed by bigger moves:
- A second, convincing break: an initial dip lower or peek higher triggers the opposite reaction from those waiting to take a profit. However, if the forces behind the move are strong enough, a second move might not find the same resistance anymore.
- A pullback deep into the range: After testing the extremes a bit too much, the pair can reverse and return towards the middle of the range.
How can you determine where the pair will move next? This depends a lot on what’s going on in the markets. In the first case, the move is justified, but only ran into stops. In the second case, it was a false alarm.
EUR/USD False Break Example Click image to enlarge
Example: EUR/USD broke above 1.30 on news that the Eurogroup reached an agreement on Greece. However, this was a half baked decision with many details awaiting discussion. So, after an unconvincing move above 1.30, the pair dropped below this line and later continued down in a rather one-sided move down to 1.2924.
Where would the Stop Loss / Take Profit points be?
As a general rule of thumb, the 15% rule can be used. This results in a risk/reward ratio of 30:70, or 1:2.33.
In case of a second, real breakout, enter the trade at 15% out of the range after a false break, place the stop loss point 15% into the range and the take profit at 85% above the range.
For example, if the range was calculated by yourself as 1.28 to 1.3 (200 pips), this rule would yield an entry at 1.3030, SL at 1.2970 and TP at 1.3170.
In case of a false break that results in a return to range, enter the trade at 15% back into the range after a false break, the SL at 15% out of the range and the TP at 85% deep into the range.
In the example of 1.28 to 1.30, the entry would be at 1.2970, SL at 1.3030 and TP at 1.2830.
These are only examples and not trade recommendations.
What do you think? Do you trade false breaks?
Further reading: 5 Most Predictable Currency Pairs
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Comment by Peter jcp on November 27, 2012 at 9:35pm -
Hi Yohay - yes I trade both break outs and false break outs successfully but like everyone will get caught out at times. Yesterday and today and I have been fairly fortunate catching the top of the EU at 3006 area and the present bottom at 2915.
In both cases I was able to exit trades within a few pips and on the 2915 - take a scalp buy at 2917. My stop would be 1 pip below low in this case.
I do differ with a lot of traders who say don't try "catching falling knives" or stopping "fast moving trains".
There is an art and a skill to it - and I am helped by being an experienced scalper and having many years behind me in which i have taken probably near or over 10k live trades.
In fact I would advise any trader who as not already taken over 500 demo trades to not attempt this live unless on a low stake and being prepared to fail.
The way I do it is very unusual and involves a stop watch and a 10 second tick chart and a few other aides that you would never read about.
I would prefer not to just give away all my "crown jewels" after taking years to develop and get to the stage I am at - but will say to all other traders it can be done ;-)) and many here have seen me do it in the forexmosgate group most days.
I know of one other trader here who actually does it a "slighty" different way but he has a lot more experience than me and I am sure he would probably say after you have been trading over two decades - its gets easier and you can read things in a chart normally not noticed.
Besides being able to read TA at an high level - you also need to understand market "gameplay" which as actually changed in the last few years due to more electronic platforms and HFT.
Actual logistics of stakes entering and exiting plays a part as well as the prior movement and the sentiment being set. Remember the players need not set up false sentiments all the while - out of every 10 say they manufacture - 4 or 5 might be real directional moves
The market will do it best to psychologically put you "off the scent" examples include 2 way false moves - breaking S & R by say 5 -7 pips - very slow 15 mins - then quick spikes etc etc
Normally the S & R involved will not be a key 4 hr or daily one but an interim one - that is so important. For traders who don't mind having say 70 -100 pip stops - they might not mind retraces of say 25 -40 pips - but for me those trades can be worth RR's of 4 - 6 and money wise are like the 100 pip stop trader bagging over 400 pips.
So in conclusion - I would advise all traders to be proficient on daily / 4 hr /1 hr and 30 mins charts - and then over a period of say 3 - 6 months become experienced at reading charts under 5 mins time frames and watch what happens - and take note ;-))
Its a whole new ballgame and can compliment your normal trading.
Regards
Peter
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