Your task as a trader
is to find the right battlefield
and wait just to see who wins
and who loses.
Curtis Faith “The Way of the Turtles”
Today we are going to review one of the most famous trading strategies in the world of professional Forex trading – trading breakouts. There are many systems based on this principle, hundreds of different indicators (different modifications of Moving Averages, Alligator Bill Williams and many, many others) are aimed specifically at identifying a breakout and, as a result, making a profit from this knowledge. Let’s try to figure out what a breakout is, and most importantly, let’s learn how to make money on it.
The essence of the phenomenon
Markets are the psychology of the crowd, expressed in the charts of trading terminals. We, traders, earn on the movements of the market. It’s clear that a sluggish market can hardly bring us big profits. In general, there are two key opportunities to derive profit:
- Trading in small movements with large lots.
This approach is typical for large companies, transnational banks, hedge as well as pension funds, with working capital of hundreds of millions and billions. Even with a minor change in the price brings substantial profits. For example, 0.1% of $1,000,000,000 accounts for $1 million. Needless to say, it’s a noticeable figure for any company.
- Trading in large movements with small lots.
The given approach is often utilized by ordinary traders with rather a limited capital. If your capital accounts for $1,000, then 0.1% will bring you just $1, and it can’t suit us. That’s why, using indicators, fundamental, technical analysis, we try to catch powerful price movements – breakouts.
Simplicity and reliability are your friends
The more complex any technical device, the higher the probability of its breakdown, and this truth can be confirmed by any engineer. The probability of breakage of a hammer or scrap, even with an active daily operation, is shockingly low, which can’t be said about a mobile phone or an electronic clock.
As a rule, trading indicators are quite complex things. What’s more, if you apply individual settings (for example, you can change the periods at Moving Averages), the overall process will become even more complicated. Average prices for 20… 30… 50 days, painted in different colors, intertwining and diverging among themselves, look, of course, beautiful, but we first of all wonder how all this vivid stuff could really help us to earn.
We had an opportunity to see graphs of trading terminals, which were overloaded with indicators so that the most important thing at the moment – the price – wasn’t visible at all. Instead, we saw the everlasting waves, stripes, corners, moving averages of all kinds, not to mention the Fibonacci grids.
Some traders spend hours analyzing the indicators, giving often conflicting signals (and almost always – lagging), but the overall efficiency of their trading is quite mediocre.
The eternal deceiver
The price is the eternal deceiver. Once we open an order and the price immediately goes against our position. You close the deal and the price (as if mocking) rushes in the direction you’ve just predicted. It’s a familiar situation, isn’t it?
If you don’t want the price to deceive you, striving for simplicity is what you should do. Indicators (especially if there are too many of them) can show you ten different signals. However, there’s something, which can’t deceive us. That’s the price, especially in the long run. If it’s a bullish trend, the price (with all its false breakouts and rebounds) has to go up. It’s also true for a bearish trend.
Before the invention of all these modern indicators, traders, even in the XIX century, just watched the breakouts of highs and lows (day, week and month). The price needs to break yesterday’s peak to go up. On the contrary, it has to break yesterday’s minimum to head south. Otherwise, it’s not a trend, but a flat.
An analogy with physical education lessons
Each of us probably remembers school physical training lessons, and three commands: “Ready”, “Set”, “Go.” Well, trading breakouts is about the same.
«Ready» – is a constant monitoring of the market for a certain exchange commodity. Here we recognize the long-term trend, mark the daily highs and lows on the chart and observe.
«Set» – that’s at the breakout of the daily maximum and minimum chosen by you. Get ready. If the breakout isn’t false, the price will further rise or dive.
«Go» – you’re observing a breakout of the maximum or minimum for two consecutive days. You need to open an order in the direction of this breakout. Probably, the movement will continue in this direction.
Buying the Call option
1. Study the extended chart of the selected option on the H1 timeframe.
2. Mark the daily price highs with a horizontal line.
3. At the breakout of two highs in a row you need to buy the Call option
Buying the Put option
1. Study the extended chart of the chosen option on the H1 timeframe.
2. Mark the daily price lows with a horizontal line.
3. At the breakout of two daily lows in a row you should buy the PUT option.
Tips for trading breakouts:
- Breakouts are often observed after the release of important news, so choose the asset that you are going to work with. In the calendar you should note important news for yourself and at the specified time get ready to trade.
- To distinguish a true breakout from a false one (when the price gets back to the previous level, but does not go further) is very simple using the history (hindsight), although it’s very difficult to do it online. Here only a long experience of real trading can help. A decent trading experience can’t be replaced with anything.
- Don’t forget about such an essential thing as risk management. You need to accurately calculate the size of your position. At a really powerful breakout quotes “go crazy,” in a few seconds, fluctuations can amount to hundreds of ticks, back and forth. It’s a great chance for earning, but the opposite side of it is a real chance to catch a loss. The movement of prices in any direction shouldn’t eat up your deposit. That’s an axiom. Without taking it into account, there‘s nothing to do in the market.
Examples of real trading at the broker Finmax
- Financial instrument: USD/CAD
- Expiration period: 10 minutes
- Bid in the amount of: $75
- Our forecast: UP
- Click the “Buy” button and watch the result.
In order to buy the Put option in the Finmax terminal, we will perform the following simple steps: just go to finmaxbo.com, prepare the option, specifying:
- Financial instrument: USD/JPY
- Expiration period: 20 minutes
- Bid in the amount of: $50
- Our forecast: DOWN
- Click the “Buy” button and watch the result.
You should have an action plan for any scenario. You don’t need multipage abstracts. Instead, you need a few lines, a simple scheme of actions: “If it happens … then I will do the following…”.
Example: “If after the Call option on EUR/USD the price goes down, I will buy the Put option”. Come up with a strict scenario for any variant of the market situation on the required exchange commodity. Moving of the price in the opposite direction, against your forecast shouldn’t bring you a feeling of fear or stupor, it’s not professional. If the price starts going against you, ithout unnecessary emotions, go to a previously developed alterative plan. It should become a habit of yours.