What is a false breakout?
A false breakout is a failed breakout – so, before unpacking one, it’s important to ascertain what a ‘real’ breakout is.
A breakout is a market movement that happens when the price for an asset breaks out of its normal price range, either the support level or resistance level. When the market price shoots significantly higher or lower than usual, that’s called a breakout.
However, in order for something to truly be considered a breakout, this momentum has to be sustained and can’t simply be a brief uptick in price. If a stock or another underlying asset rises out of its support or resistance level, only to revert back down again shortly afterwards, this is what’s known as a false breakout.
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Breakouts vs false breakouts: the difference
Breakout
Breaks through (rises above) the resistance level and continues to appreciate in price, or breaks through (dips below) the support level and continues to depreciate in price.
False breakout
Breaks through (rises above) the resistance level or breaks through (dips below) the support level, but only momentarily – failing to sustain momentum.
How to identify false breakout patterns
It can be tricky to identify when a breakout is genuine and when it’s a ‘failed break’, as false breakouts are sometimes called. Fortunately, there are ways to recognize them.
One of the simplest ways to identify a false breakout is to make a note of how long it lasts. Because failed breaks are fleeting, watching your chosen asset for a while is often an effective way to tell if a breakout is genuine or not.
Similarly, you can study the price history of false breakouts and true breakouts over time. This can help to you recognize where a current break may resemble previous ones that turned out to be false. Just remember that past performance isn’t always an indicator of future results, so let these figures inform you rather than decide for you.
Another crucial step to identifying a failed break is technical analysis, to help you to determine what your chosen market’s support and resistance levels are. This provides key insights when trying to differentiate between a breakout and a false breakout.
A breakout can be more likely to be false when it hits the same support or resistance level a number of times but has always pulled back from this point before. However, the more unusual it is for an underlying asset to break through a certain price range, the more likely it’s driven by true momentum and high volumes – often the sign of a true breakout.
How to avoid a false breakout
It can be almost impossible to tell a true breakout from a failed break if you don’t know what to look for. Here are four ways to avoid a failed break:
Take it slow
One of the simplest ways to avoid a false breakout is also one of the most challenging for many traders and investors – to simply wait. Instead of buying in to the trend the moment your asset breaks through its support or resistance level, you can give it a few minutes, hours or even days (depending, of course, on your trading style and its timeline) and watch as, often, the failed breaks simply weed themselves out.
Watch your candles
A more advanced version of waiting it out can require a candlestick chart. When you suspect a breakout is happening, wait till the candle closes to confirm its strength. The stronger the breakout appears, the more likely it’s not a failed break.
While this can be an effective way to identify false breakouts, many traders and investors don’t have the time to sit and watch their chosen chart around the clock. That’s why, with us, you can set alerts to notify you of the specific market conditions you’re waiting for. In the case of a breakout, for example, you’d create an alert based on candle’s close price, to notify you of any potential breakouts.
Use multiple timeframe analysis
Another efficient way to identify breakouts, and what of those are likely failed breaks, is multiple timeframe analysis. This entails watching your chosen market using a variety of different timeframes. When using this technique, you’d likely spot the potential for a breakout in the short term, then ‘zoom out’ to view that same market over a week, a month or even longer before opening a position.
This helps with identifying a false breakout because you’re paining perspective of your asset over both the longer and shorter term. Studying its patterns can show if what you think is a breakout is actually significant in the context of that market.
Know the ‘usual suspects’
Some patterns in charts can indicate the likelihood of a false breakout. These include ascending triangles, the head and shoulders pattern and flag formations.
Learning how to identify these patterns can help you to tell the difference between a breakout and a false breakout, as these three formations are often associated with failed breaks. For example, ascending triangles are indicators of a temporary market correction rather than a true breakout.
How to trade a false breakout
While it may sound counterintuitive, there are also times when you may want to take a position on false breakouts.
For example, say you’re a forex trader with your eye on a certain market. Because buying a forex pair seeks to profit from a rising price, you may want to buy low and sell high – meaning you’d potentially buy in to the market once its price dips below the support level.
If this is indeed a false breakout and the market bounces back, you could sell your forex pair to benefit from this increase in value. However, there’s also the chance that the market will instead continue to fall (a true breakout), which means that your position would be less valuable.
- Choose the forex market you’d like to trade
- Open an account to get started, or practice on a demo account
- Choose your forex trading platform
- Open, monitor, and close positions
Trading forex requires an account with a forex provider like tastyfx. Many traders also watch major forex pairs like EUR/USD and USD/JPY for potential opportunities based on economic events such as inflation releases or interest rate decisions. Economic events can produce more volatility for forex pairs, which can mean greater potential profits and losses as risks can increase at these times.
You can help develop your forex trading strategies using resources like tastyfx’s YouTube channel. Once your strategy is developed, you can follow the above steps to opening an account and getting started trading forex.
Your profit or loss is calculated according to your full position size. Leverage will magnify both your profits and losses. It’s important to manage your risks carefully as losses can exceed your deposit. Ensure you understand the risks and benefits associated with trading leveraged products before you start trading with them. Trade using money you’re comfortable losing.
False breakouts summed up
- A false breakout is a significant movement out of a market’s normal support or resistance levels that doesn’t last – hence it ‘fails’
- These can cause costly mistakes for traders thinking a market has hit a true breakout and to go long, only for it to lose momentum shortly afterwards
- You can avoid false breakouts – or trade them intentionally – by studying your chosen market and knowing the chart patterns timeframes and other signs of a failed break
- With us, you can trade on breakouts and failed breaks using spot forex markets
