Breakout strategy: How to be successful with the Busted Breakout strategy
Breakout strategy: your stop has been hit – again? You should become the hunter and achieve a profit from the trader-trap. Enter the trade when others have to exit and watch others get caught in the trap – to your advantage!
» Psychological Traces in the Market
The search for low-risk trading patterns has always been the most important task for traders and investors. That hasn’t changed much. The main goal is to find situations where rewards exceed risks considerably.
It is still a major advantage if you are able to read and use explicit, recurring and profitable patterns in the market. At certain points in the chart, where buyers and sellers meet in high tension, there can be a strong power play. These situations leave a clear trace in the market (visually as well as psychologically) and therefore they can be used for profitable trading.
Goal of the Breakout Strategy
The Busted Breakout Strategy is based on a specific consolidation pattern in the forex chart and profits from false breakouts within the superior trend. The so-called trader-trap is one of the most important aspects in addition to other advantages. The trap develops because of counter- trend traders, often inexperienced and have a big ego trade against the market. They try to trade breakouts against the trend direction. But there are often “safe” situations that reverse into the red in a flash and therefore cause big losses for many market participants (trader-trap). The market does not teach one thing for nothing – humbleness.
The strategy says, that you should enter a trade early at the first signs of a fake breakout with a tight stop- loss to profit from the panic that will start. Typically impulsive movements develop because of the dilemma in the market that will strengthen due to the ending of fishing. The goal is to bring your own position into profit as soon as possible with this first movement of impulse. After that first move you can also profit from the superior swing-movement of the trend continuation.
A previous consolidation pattern in the trend development is important, because many countertrend traders (ideally in different time frames) have to be “convinced” that the existing trend is now over and the counter movement is about to start.
It is important to consider the superior time frame – compared to the entry chart – to enable the reliability of the strategy. The average hit rate is 65 per cent. A clearly defined entry and a tight stop-loss are further advantages of this strategy.
The Setup of the Breakout Strategy
The trade setup consists of three phases: (I) build-up of pressure in the trend, (II) the trader-trap as well as (III) end of fishing and trend continuation. In this strategy it is important to analyse the entry chart as well as the higher time frame (HT). Typically the higher time frame is defined as four to six times higher than the entry chart. For example: 15-minute time frame – the higher time frame is the 60-minute chart.
The first two phases determine the setup. The rules for the long-entry are as follows (short entry vice versa):
(I) Build-up of Pressure in the Trend:
a. Higher time frame (HT): exponential moving averages (EMAs) in correct order, which means 8EMA>21EMA>50EMA. This is valid for the last 15 candles in the HT.
b. Impulse movement before consolidation: span of impulse at least 6*ATR(14) (ATR = Average True Range) based on the start until the end of the swing move.
c. Consolidation: consolidation pattern on the horizontal line with at least five touches (ideally lower highs form)
(II) Trader Trap:
a. Higher time frame (HT): price in HT within the exponential moving average band (8/21 EMA)
b. Breakout: breakout-candle with close below the horizontal line of the consolidation. Clear and dynamic breakouts with little follow-up- movement are the best.
c. Re-break: After the breakout-candle has formed the price has to move back above the horizontal line. The re-break can happen directly after the breakout-candle or a few candles after.
The entry is done directly at the re-break above the horizontal breakout-line that confirms the trader-trap. You place the stop in the market at the same time as the entry. The stop is placed a bit below the low of the breakout-attempt.
The profit target is calculated based on a 100 per cent projection of the previous swing-move and is placed at the breakout-low. After the entry we expect a movement about the same size as before the busted-breakout-pattern. The reward-risk-ratio (RRR) must be larger than 3. Because of the tight stop this should not be a problem in most cases (see Figure 1). We exit part of the position after the stop- fishing or alternatively after reaching a book profit of 1.2-times the trade-risk (1.2R). After closing out a fourth of the position and placing the stop below the breakout-line the position is break-even. Therefore the stop is protected in some way. 20 per cent of the time the breakout-level is retested. We trail the stop for the remaining position at 25 per cent profit every time a new high is reached until the profit target or the stop is hit.
Breakout strategy: Dogmas as Strong Basis
Strong trading systems that generate stable profits in the long term are based on a strong fundament of dogmas. You can only be profitable with this system if you agree and identify with the following dogmas:
• Market trends usually run longer than the market participants can imagine.
• Price-consolidations within a trend are short refreshers. They are necessary for the trend to strengthen again before it continues.
• Market participants leave “psychological footprints” in the chart, that can be recognized as specific visual patterns. If you understand the underlying emotional dynamic it is a great advantage in the market.
• The “masses” in the financial markets are wrong
most of the time and lose heavily.
• Traders with big egos have difficulties being
• The strongest and most reliable movements develop, if market participants are caught in a dilemma (trader-trap).
Breakout strategy: Real Examples
The example in Figure 2 (GBP/USD, long) shows very well that there is a clear consolidation within the trend development on the horizontal line with seven touches (see light green line number 1 to 7). On 1st July 2014, between 15:00 and 06:00 the following day sellers and buyers watched each other carefully. Therefore there was a build-up of pressure for the continuation of the trend. Because of the length of the consolidation (15 hours) more and more market participants noticed this situation. Counter-trend traders became more and more convinced that a short-entry after the breakout will be successful the longer the consolidation takes.
The tension grew (see several small candles near the line) and the decision – either way – had to be made. There were several breakout attempts below the green line. The re-break confirmed the trader-trap and led to the entry of the long-position (1.7102). The stop (1.7093) is well protected and is below the horizontal green line, the relevant big number 1.7000 as well as the low of the breakout-attempt. The profit target (1.7162) equals a RRR of 5.3.
How can you read this situation regarding the “psychological footstep”? The counter-trend traders opened their short-position with the dynamic breakout- candle. Some stops were placed directly at the line and some at the highs of the consolidation. The positions showed first signs of weakness because the price broke the strong resistance of the breakout-line to the upside (re-break). Tension increased and created the necessary emotional pressure (trap-in). The state of shock of the countertrend-traders started. The cascading stops in the market are not to far away and act like a magnet.
Furthermore there is a second group of market participants that can be caught in the same trap: Buyers, who had their long-position for some time and made good profits. They fear losing part of their profits and therefore there is the tendency to protect their profits tightly. The stop is placed on an allegedly safe stop below the horizontal line and the stop is hit with the breakout- movement (trap-out). The trader fears that the trend will continue and therefore re-enters (because he does not want to miss this chance) and that increases the price additionally. You can see the stop-fishing of all stops clearly with a strong impulse movement, that reaches above the highs of the consolidation (long green candle). We exit part of the position at a RRR of 1.5 at 1.7120 and place the stop below the breakout-line and therefore the trade is break-even. The profit target (100 per cent-projection) is reached a few hours later and the trade is closed at 1.7162 with a profit of 4.3-times the risk.
Another example is the CHF/ JPY currency pair in the weekly chart (Figure 3). The impulse movement (swing move) as well as the consolidation are similar to the one in the previous example (Figure 2). The requirements of the setup for the higher time frame – the monthly chart – are fulfilled; the same goes for the impulse-span of the previous swing-move, which is more than 8ATR.
The entry (113.02) and the stop (110.80) are executed and placed after a clearly failed, dynamic breakout-attempt below the green line. The candle following the breakout-candle, a hammer, shows the relevance and strength of the horizontal line. If you are a trader of the Busted Breakout Strategy, you can relax after the entry because you can trust that all advantages are on your side. The RRR is 4.7 and we exit part of the position at 120.00 after the stop-fishing at the level of the highs of the consolidation. The profit target at 123.26 is reached quickly and the trade is closed with 4.4-times the initial risk.
Breakout Strategy: Practical Implementation
The strategy was originally developed for the forex market. But it also works on liquid and deep markets like indices, bonds and commodities. Because of the fractal nature of the markets all time frames – from tick- to weekly chart – can be traded. The strategy applies to both discretionary and automated trading system.
It takes some practice to identify visual patterns in the market. If you trade fully automated, you have to concretise the rules further to duplicate the intuitive component of the pattern recognition. A big advantage of the forex market is the 24-hour-trading. The strategy works well during all trading times.
Be aware that the setup and the entry are only a part of the trading strategy. A differentiated exit-algorithm, a dynamic position-sizing, the definition of the market typology as well as risk management are further important components of the system.
Breakout strategy: Conclusion
It is important that you agree with the dogmas of the system to trade it profitably. The difficulty of the strategy is that you have to trade against the masses of people. The entry is often contra-intuitive – but do not let that disturb you! Because that is the reason why the strategy works so well. It is definitely more fun to profit from other stops than to be stopped out with a loss. Which group do you want to join? «
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