Trading False Breakout in Weak Trends

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Many traders try to trade breakouts, but many of those breakouts fail resulting in a losing trade. A failed breakout is when the price moves beyond a former high or former low, making it appear like the price is going to continue to run in that direction. Instead, the price quickly reverses, trapping a bunch of traders in a losing position. Instead of getting frustrated by false breakouts, learn to trade them and profit from them. Here’s one way to do it.

Watch for Weak Trends

First we need to isolate forex pairs, or other assets, where a false breakout is likely to occur. False breakouts often occur in weak trends.

A downtrend is weak when the price is making lower swing lows, but just barely. The price will make a new low, then reverse course. The price is “drifting” lower, as opposed to getting “hammered” lower. Since we are going to be buying when the trend is down, we need the trend to be weak. We don’t want to buy in a downtrend when that trend is strong and the price is creating significantly lower lows on each price wave.

An uptrend is weak when the price is making higher swing highs, but just barely. Figure 1 shows an example of this. The EUR/USD is just barely making higher highs. This shows some potential underlying weakness, as the bulls are just barely stronger than the bears. Therefore, if we know how to trade it, we can take short position within this pair and make money even though the trend is slightly up.

Figure 1. EURUSD Daily Chart with Weak Uptrend

Introduce the Trendline

Now that we have isolated a weak trend, in this case a weak uptrend in the EUR/USD, we mark former high points with horizontal (red) lines. This way, when the price makes a new high it is visible.

We then put trendlines on the waves higher which created the new high. Figure 2 shows these two steps applied to a few trusts higher in the EUR/USD.

Figure 2. EURUSD Daily Chart with Highs and Waves Higher Marked

The horizontal lines (red) mark former highs, so assuming we have a weak trend when the price crosses above the red line we want to watch for a false breakout. If the price moves above the former high (red lines) but then quickly reverses course (in this cause, down) we have a potential false breakout.

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Our trendlines help us confirm the false breakout. If the price just barely creates a new high and then drops below our trendline, enter a short position as the price crosses below the trendline. Typically the price will fall fast as lots of traders are forced to liquidate because the price failed to rally as expected.

Figure 3. EURUSD False Breakout Trades

In each of these cases we had evidence to suggest that the uptrend wasn’t very strong. Even so, we give the weak uptrend some credit and give it a chance to move higher. This is why we wait to go short until the price crosses below the trendline.

Other Considerations

This is a generic strategy, in that it will need your own personal touch to make it usable. If you’ve isolated a weak trend and spot the false breakouts, the price will typically move in your favor, at least for a short while. If trading traditional markets (such as forex) risk control can be an issue, since false breakout bars can be quite large, and if you place a stop above it your stop could be quite large as well.

Therefore, you’ll have to balance the risk with reward. Fibonacci Retracement levels provide viable exits, with the 50% level being a frequent target price. Based on the entry, stop and target, your reward should be greater than your risk; if it isn’t skip the trade.

For binary option traders you’ll need to establish your expiry. Look at the history of prior false breakout trade set-ups to find an average expiry time which provides the greatest potential of the option expiring in the money.

While daily charts were used in this example, the strategy is usable on all time frames.

The same strategy applies to weak downtrends.

Final Word

We don’t want to short into a strong uptrend (or buy into a strong downtrend), only when the price trend is weak should we apply this strategy. This is only a partial strategy, as it just gives the entry point. While the price will typically run in our favor for a time, it is up to you to complete the strategy by finding a viable exit on the timeframe you trade on.

False Breakout Trading Strategy

False Breakout Patterns

False-breakouts are exactly what they sound like: a breakout that failed to continue beyond a level, resulting in a ‘false’ breakout of that level. False breakout patterns are one of the most important price action trading patterns to learn, because a false-break is often a very strong clue that price might be changing direction or that a trend might be resuming soon. A false-break of a level can be thought of as a ‘deception’ by the market, because it looks like price will breakout but then it quickly reverses, deceiving all those who took the ‘bait’ of the breakout. It’s often the case that amateurs will enter what looks like an ‘obvious’ breakout and then the professional’s will push the market back the other way

As a price action trader, you want to learn how to use false breakouts to your advantage, rather than falling victim to them.

Here are two clear examples of false breakouts above and below key levels. Note that false breakouts can take different forms. Sometimes a false break will occur with a pin bar pattern or a fakey pattern as the false break, and sometime not:

A false breakout is essentially a ‘contrarian’ move in the market that ‘flushes’ out those traders who may have entered on emotion, rather than logic and forward thinking.

Generally speaking, a false-break is happens because amateur traders or those with ‘weak hands’ in the market will tend to enter the market only when it ‘feels safe’ to do so. This means, they tend to enter when a market is already quite extended in one direction (and it’s about ready to retrace) or they try to ‘predict’ a breakout from a key support or resistance level too early. Professional traders watch for these missteps by the amateurs, and the end result is a very good entry for them with a tight stop loss and huge risk reward potential.

It takes discipline and a bit of ‘gut feel’ to know when a false-break is likely to occur, and you can never really know ‘for sure’ until after one has formed. The important thing, is to know what they look like and how to trade them, which we will discuss next…

How to trade false breakout patterns

False breaks occur in all market conditions; trending, consolidating, counter-trend, but perhaps the best way to trade them is in-line with a dominant daily chart trend, like we see in the chart below.

Note, in the chart below, we had a clear downtrend in place and multiple false breakouts to the upside within that trend. When you see a false breakout that is against a dominant trend like this, it’s usually a very good signal that the trend is ready to resume. Amateur traders love to try and pick the bottom in a downtrend or the top in an uptrend, and this can cause false breakouts against the trend like we see below. On each of these false-breaks in the chart below, it was likely that amateur traders thought the downtrend was over and so they started buying, once this buying started the professionals came back in and took advantage of the temporary strength within the down-trending market and entered short from value, and then the downtrend resumed, flushing out all those amateur traders who tried picking the bottom.

The chart below shows examples of false breakouts within a down-trending market. Note that each one led to a resumption of the trend…

False-breaks are prevalent in trading ranges because traders often try to pick the breakout of the range but usually price stays range-bound for longer than most assume. Knowing that false-breaks are somewhat common when a market is struck in a trading range is a very valuable piece of information for a price action trader.

Trading a range-bound market can be very lucrative as you can wait for price action signals at the support or resistance boundary of the range to trade back toward the other side of the range.

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.

In the chart below, we can see how a price action trader can use a false breakout pin bar signal to trade a false breakout of a trading range. Note the false break pin bar at the trading range key resistance, and also note the two false-breaks at the trading range’s support. More experienced traders can also trade false breakouts that don’t contain a price action trigger like a pin bar. The two false-breaks of support in the chart below were both potential buy signals for a savvy price action trader…

False breakout patterns can sometimes signal the beginning of a new trend, and the end of the current one.

In the chart example below, we can see a key resistance level that held price on two tests, then on the third test, price created a large false-break pin bar strategy that signaled a potential down move was coming.

As we can see in this chart, not only did the false breakout signal a down move, but it kicked off an entire downtrend…

False Breakout Pattern Trading Tips

  • False breakouts occur in trending markets, range-bound markets and against the trend. Watch for them in all market conditions as they often give strong clues as to impending market direction.
  • Trading counter-trend is difficult, but one of the ‘best’ ways to trade against a trend is to wait for a clear false breakout signal against a trend from a key support or resistance levels, as shown in the last example above.
  • False-breakouts give us a ‘window’ into the ‘battle’ between amateur and professional traders, hence, they give us a way to trade with the professionals. Learn to identify and trade false breakout patterns and trading will take on a different light for you.

I hope you’ve enjoyed this false breakout pattern tutorial. For more information on false breakout patterns and price action trading click here

The ‘False Break’ Trading Strategy

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.

3. Fakey’s (inside bar false-breaks)

The Fakey setup is one of my all-time favorite price action setups and learning to trade it will do a lot for helping you to understand market dynamics. Essentially, the Fakey is a price action pattern that requires there to be a false-break of an inside bar setup. So, once you have an inside bar setup, you can watch for a false-break of the inside bar and the mother bar. Now, I am not going to get into all the different versions of the fakey trading strategy today or the different ways to trade it, but you can learn everything about my proprietary forex fakey trading strategy in my professional Forex trading course.

Here’s an image of two Fakey setups, note that one has a pin bar as the false-break and other does not, these are just two of the variations of the Fakey setup:

False-breaks can create long-term trend changes

As price action traders, we can use the price action of a market to anticipate false-breaks and look for them at key levels as they will often set off significant changes in price direction or even a change in trend from these key levels.

We need to pay attention to the ‘tails’ of candles that occur at or near key levels in the market. Ask yourself how prices reacted during each daily session…where did they close? The close is the most important level of the day, and often if a market fails to close beyond a key market level, it can signal a significant false-break. Often, prices will probe a level or attempt to break out, but by the close of the daily bar price has rejected that level and ‘tailed out’, showing a false-break or false-test of the level. A failure of the market to close beyond a key market level can lead to a large retracement or a change of trend. Thus, the close of a price bar is the most important level to watch, and the daily chart close is what I consider to be the most important.

Here’s an example of a false-break in the EURUSD daily chart that led to a top in the market and started a long-term downtrend:

History Teaches Us A Lesson

It’s worth noting that on the week famous trader George Soros shorted the British pound and ‘broke’ the Bank of England ( September 16, 1992) – the chart had shown a massive false-break signal. The chart below shows the price breaking upwards to new highs and then crashing back down. To those who follow me regularly you will note that this was actually a classic fakey setup, and is clear evidence that this price action strategy has worked for decades.

Final word on false-breaks…

As traders, if we don’t learn to anticipate and identify deceptions or ‘false-breaks’ in the market, we will lose money to traders who do. If we pay attention to the price action at key levels on the daily chart time frame, the ‘writing’ is usually on the wall in regards to false-breaks.

If I had to leave you with one crucial piece of advice for your Forex trading career, it would be to drop everything right now and start studying false-breaks and contrarian trading approaches. By doing so, you will be ahead of 95% of traders who are stuck in a cycle of trading off mainstream misconceptions and ineffective trading methods. As a contrarian, I want to be trading when most other retail traders are committed to the wrong side of the market, and this is difficult to do if you don’t understand false-breaks and fakey patterns. Trading false-breaks and my proprietary ‘fakey setup’ is a core focus in my Forex price action trading course, and I expand on these topics in great detail in it. I teach my students a plethora of different price patterns to look out for when trading false-breaks and fakey setups. This ‘contrarian’ style of trading is something I strongly believe in, and it has proven itself time and time again. If you were to learn only one single trading strategy to apply in your Forex trading, false-breaks would be on top of the list.

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