Trading Blogers

In order to employ the breakout fading strategy, you should be able to identify likely false breakouts. There are some technical formations where the false breakouts are more likely to occur in the currency price charts. You need to apply a lot of common sense in identifying a false breakout.

Head and Shoulders Pattern: This chart pattern is the hardest for new traders to identify. The head and shoulder pattern consists of three points of rallies. The middle rally is the highest with the left and right being smaller. The pattern resembles the head and shoulder pattern of a human. Dont confuse it with a shampoo. A neckline can be drawn connecting the lows of the left and right shoulders.

If the head and shoulder pattern is found at the end of an uptrend, it signals a bearish reversal or a consolidation period before the uptrend is continued. The head and shoulder pattern is usually found in the middle or end of an uptrend. An inverted head and shoulder pattern can also be found in the middle or end of a downtrend.

If they are buying up the rallies from the support level, many traders who have identified the head and shoulder pattern as a possible breakout signal place their stop loss orders below the neckline. Head and shoulder patterns are notorious for precipitating a false breakout.

Similarly, if traders are shorting the decline from the resistance level, they place their stop loss orders above the neckline of the inverted head and shoulder pattern. Traders can also place numerous entry stop orders below the neckline. Traders can also place entry stop orders above the inverse neckline in anticipation of a breakout besides the stop loss orders.

False breakouts are triggered by the market makers to shake out the positions of small traders most of the time. Prices will usually rebound. There maybe explosive price movements off the neckline in the pre breakout zone.

It is always best to assume that the first break of a head and shoulder pattern tends to be false. You may choose to place a stop loss slightly below the high of the second shoulder or slightly above the low of the second shoulder. You may fade the breakout with a limit of market entry order a few pips above the neckline or a few pips below the inverse neckline.

Double Top and Double Bottom: The problem with this chart pattern is also this that it is used by novice traders as a signal for possible breakout. A double top formation consists of two rally peaks separated by a valley. The two peaks need not be of the same height. A double bottom is simply an inverted image of a double top.

Using this chart pattern as an indication for a likely breakout makes these traders easy bait for the big players. Fading breakout is more effective in range bound markets. The breakout fading strategy usually does not work well when the market is in a strong trending phase.