How to Recognize a Fake Breakout?
Fake Breakout is one of the most challenging aspects of Forex trading. Fake Breakout is a term used in Forex trading to describe a false breakout when the price breaks through a key support or resistance level but reverses its course and returns to its previous trading range.
Contents
Why do fake price breakouts happen?
Fake breakouts can occur for various reasons. Two of the most common reasons are:
- Market manipulation
- Market fluctuations
Stay tuned for the explanation of these reasons.
Market Manipulation: Traders or large institutions may use Fake Breakouts to manipulate the market and generate false signals. They may push a currency pair's price above or below a key level so that the price hits stop-loss orders and traps traders on the wrong side of the market.
Market Fluctuations: The Forex market can be volatile, especially during news events or major economic announcements. High volatility leads to sudden and unexpected movements, even in minor currency pairs , which can result in fake breakouts.
How to recognize a fake price breakout in the forex market?
Here are some methods on how to spot fake breakouts in forex trading.
These methods include:
- Using multi-timeframe analysis
- Understanding market trends
- Identifying price patterns
- Using technical indicators
- Observing trading volume
- Attention to news events
We will explain each of these methods below.
Using multi-timeframe analysis: One of the best ways to avoid detecting a fake breakout is to use multiple time frames when analyzing the market. This technique allows traders to see the bigger picture of what is happening in the market and identify key trends and patterns that drive prices. For example, if a trader uses the 15-minute chart to trade, he should also look at the 1-hour and 4-hour charts to understand the overall trend better. Traders can avoid getting caught up in short-term swings that might lead to fake breakouts this way.
Read More: Multi-time frame (MTF) or Time analysis for trading in the forex market
Understanding the Market Trend: The first step to spotting a fake breakout is understanding the market trend. Fake Breakouts usually occur when the market is in a bearish or neutral trend. Traders should identify the trend, and if the market is in a ranging trend, they should be extra careful of fake breakouts because they are more likely to occur.
Identifying Price Patterns: Price patterns are essential tools for forex traders to identify fake breakouts. Traders should look for patterns such as triangles, heads and shoulders, and double bottoms or tops. These patterns provide clues about the market's direction and can help traders identify potential fake breakouts. For example, a double-top pattern may indicate a potential fake-out because the market will likely reverse after testing the resistance level.
Using Technical Indicators: Technical analysis indicators are another tool that traders can use to identify false breakouts. Indicators such as the Relative Strength Index (RSI), MACD , and Bollinger Bands can help traders identify potential fake breakouts. For example, when the RSI is in the overbought zone, and a price breakout occurs, it may indicate a fake out, and a reversal is likely to occur.
Read More: Relative Strength Index (RSI) indicator and teaching its use in technical analysis
Observing Trading Volume: Volume is a fundamental factor in forex trading, and traders should monitor it to detect possible fake breakouts. A sudden increase in volume may indicate a potential fake breakout because market participants may take a position in the wrong direction. Traders should also monitor the volume in the trend because it provides clues about the market direction.
Attention to News Events: News events can significantly affect the forex market, and traders should pay attention to them to identify potential fake breakouts. For example, when a news event causes a sudden jump in the market, it may indicate a potential fake breakout because the market may return to the main trend. Traders should also be attentive to news events such as interest rate announcements or economic data releases that may cause market volatility. You can get this information from Trendo Broker's economic calendar analysis page.
Trading strategy with fake breakout
Trading fake-outs might seem impossible, but this is not correct. We can trade fake breakouts with the strategy discussed below, but to do so, we need a proper and comprehensive understanding of the market.
For Buy
The chart below shows a fake breakout in the EURCAD currency pair in the 15-minute time frame.
As you can see in the image above, we can enter a buy trade after the price falsely breaks below the support zone and quickly returns above the level. This quick return above the support level shows that the sellers failed to control the market. Now, the buyers have taken over and are driving the market to a higher ceiling.
For Sell
The chart below shows a fake breakout in the EURUSD currency pair in the 15-minute time frame.
The image above shows a fake breakout in this forex pair. This currency pair was in an uptrend, and while trying to go above the resistance line, it immediately returned below the resistance level. That confirms the fake out and allows us to enter a sell trade. The price then creates lower floors in a downtrend.
What points to consider when trading fake breakouts?
- First, find key levels on the price chart. These levels are areas that provide a lot of liquidity to market participants.
- Avoid trading with breakouts occurring in ranging or neutral trends because buyers and sellers have equal power in these moments. In this situation, the probability of sharp movements is very high, so we always recommend trading breakouts only in trending markets.
- Wait for the price to break through a key level in the uptrend or downtrend with the close of a candlestick.
- After the breakout, wait for the price to test the breakout level with a pullback to confirm the breakout's correctness.
Summary
Fake breakouts are a common occurrence in financial markets. This type of breakouts can be frustrating and costly for traders, but can also provide opportunities for profitable trades. Traders who can identify and manage fake breakouts using different strategies and techniques can increase their chances of success in the forex market.
