Time Frame Matters
The time frame you use to trade and thus identify these false breakouts is paramount to the overall effectiveness of this strategy.
To explain why this is the case, let’s revisit the EURGBP chart above.
The two instances above were clearly NOT false breaks on the daily chart as well as any time frame above the daily. The pair never actually closed above the critical level; thus we couldn’t consider it a false breakout.
But what about the 4-hour chart?
Let’s take a look.
As you can see, while the daily chart never closed above resistance, the 4-hour chart certainly did.
So was this a false break for those trading the 4-hour chart at the time?
Perhaps, but remember that one of the ingredients for any false break is an obvious level of support or resistance. The retest in the chart above occurred after just one other test of resistance.
With this in mind, attempting to trade or even analyze the price action on a 4-hour closing basis would be ill-advised.
To understand why we have to go back to price action trading 101. One of the tenants of trading between support and resistance is that you must know which time frame is respecting a given level or pattern.
In the case of the EURGBP chart above, the 4-hour had not established itself as the predominant period in relation to the resistance level.
To clarify what I mean by predominant, let’s compare it to the ascending channel that formed on NZDJPY.
Notice how NZDJPY touched both support and resistance on several occasions prior to the false breakout. In this case, the 4-hour chart was clearly respecting the pattern and could therefore be used to assess the implications of the false break that eventually materialized.
Any false break is only as valid (and telling) as the time frame on which it occurs.
So which time frame is “best” for using the technique I’m about to show you?
In my experience, the 4-hour and daily
periods work the best. However, each situation is unique, so it all depends on which time frame is respecting the key level in question.
Trading Away From False Breaks
Now that you know how to identify these false moves let’s dive into how you can take advantage of them.
Just like the pin bars we use when trading price action, a breakout that immediately fails is a sign of strength or weakness. We can use this to our advantage just like any other price action signal.
In fact, you can’t have a pin bar on the daily chart without having a false breakout on the intraday charts. The same applies to any combination of time frames.
The NZDJPY 4-hour channel below is a great example. Once the pair closed back below the upper boundary of the structure, it was time to begin watching for selling opportunities.
Note that the pair eventually found a bid right where we’d expect – at the channel support that had attracted buyers on three previous occasions.
In summary, we would have looked to sell on a 4-hour close back below resistance with a target at channel support.
Don’t Be Fooled by Failed Breakouts
Remember how I mentioned that you could have mitigated the risk of getting sucked into these traps at the beginning of this lesson?
The best way to do that is through a firm understanding of price action. And that involves more than just pin bars and inside bars
Allow me to explain.
You may have noticed that shortly after closing above channel resistance, NZDJPY formed a 4-hour bullish pin bar.
Now, you may be asking yourself, why wouldn’t we have traded that bullish signal, which ultimately failed?
Good question. The reason we didn’t commit to this particular pin bar was quite simple.
The pattern in question is an ascending channel and therefore has bearish implications. As such, we would only want to trade a breakout below channel support, which never materialized before the close above resistance.
Technically speaking, the pattern above was a bearish flag as it was the result of an impulsive move lower. That meant that any buying was counter-trend and thus not advisable.
If on the other hand a pin bar had not formed here and the level was a horizontal pivot rather than a channel, we wouldn’t want to trade the breakout without confirming price action.
What is “confirming price action”, you ask?
Simply put, it’s a bullish or bearish pin bar that forms on a retest of the broken level. It adds conviction to the setup and provides a place to “hide” your stop loss.
You won’t always be able to avoid false breakouts. No technique or strategy will keep you safe 100% of the time.
But through the combined use of technical patterns and bullish or bearish price action, you can give yourself the edge needed to make money over an extended period.
Final Thoughts
The false breakout strategy discussed above is ideal for the more advanced price action trader. If you’re just starting out or not yet profitable using the basic strategies taught on this site, you are probably better off sticking with those to first build a strong technical foundation.
Remember that like any trading strategy, technique or concept, the ideas discussed in this post are based on probabilities, not guarantees. So while a false break of a given level can often result in an extended move in the opposite direction, it does not guarantee the outcome as such.
Whether you use these teachings to formulate an outright trading strategy or only use them to assist in your technical analysis is up to you. As I always say, the “best” trading style is the one that works best for you.
As for me, I simply use the technique above as a way to gauge market strength and therefore add conviction to an already established trade idea.
Your Turn
How do you handle false breakouts while trading the Forex market?
Leave your comment or question below and I’ll be sure to respond.
