Level breakdown. The most effective setups
Updated
What is a level breakout?
A breakout is the price's consolidation above a certain level followed by further movement in the direction of the breakout. But the immediate question that should arise in your mind is about the consolidation of price, as it might be difficult for inexperienced individuals to understand. However, there is nothing overly complex about it either; consolidation refers to the candle closing above the level
A breakdown can occur at a horizontal or inclined level.
Bullish breakout:
We observe a trending market encountering resistance at a horizontal level. After two unsuccessful attempts, the price breaks through the level.
Bearish breakout:
Why do level breakouts work?
Imagine a scenario: a strong resistance level on the chart is heavily defended by bears, preventing the price from breaking through. Despite several attempts, the bears hold their ground until the bulls come to the rescue. They overpower the bears, but their strategy doesn't end there. Instead of retreating, they press forward, driving the opposition towards the next resistance level, where the cycle repeats.
Breakouts occur when the price breaches a significant level. Observing price movements on a chart reveals that prices often consolidate and encounter specific levels.
When the price reaches a level and swiftly reverses, it indicates the strength of that level. Upon a price retest of this level, careful monitoring is essential to anticipate a potential breakout.
Repeated tests of the same level signify its strength, yet eventually, the price will break through any level. This is when traders should be prepared to initiate a breakout trade.
Breakouts offer lucrative trading opportunities because they often mark the inception of new price movements and trends. By entering trades at the onset of emerging trends, traders position themselves for potential profits.
Moreover, reliable breakouts typically occur during periods of robust price momentum when traders seek to capitalize on rapid price fluctuations.
Breakouts occur at important price levels. It can be:
- Support or resistance levels.
- Patterns
- Market highs or lows.
- Trend lines.
- Price channels.
- Moving averages.
- Fibonacci levels.
One reason breakouts can lead to rapid price movements is due to the attention they attract from market participants monitoring key levels. When one group of traders capitalizes on a breakout, another group is compelled to swiftly exit their losing positions, resulting in sharp price fluctuations post-breakout.
There exist various types of breakouts, and as traders, our objective is to identify high-probability breakout opportunities and initiate trades. However, this task is not always straightforward. Consequently, levels marked at potential breakout points should be regarded as zones rather than rigid lines.
Identifying Psychologically Important Levels:
Repeated testing of a specific zone by the price often signifies its significance.
Having reached a certain level, the price enters a sideways movement, forming a consolidation. Using a rectangle, we outline the area encompassing the lower wicks of the candles, delineating our support/resistance area. When trading breakouts, it is wise to wait until the candle closes outside the support or resistance area to confirm the breakout.
Triangles are chart patterns indicating price compression, often culminating in a breakout. The direction of the breakout is typically uncertain.
Within the circle, you can observe the precise location of a potential breakout. Notably, there is a robust breakout momentum evidenced by several full-bodied candles. Subsequent to breaching the upper level of the triangle, the price retraces to test the previously breached resistance, now acting as a support area. This pullback serves as a crucial confirmation signal.
Breakouts and false breakouts:
Typically, candlestick shadow breakouts are not considered true breakouts. A true breakout occurs only when the price finally closes outside the level. This approach provides a more secure entry point, making it easier to open positions in the appropriate direction.
The upper rectangle constantly holds down the price, with the exception of some candles, characterized as a pin bar. This represents an initial false breakout as only one candle breaks the resistance area but fails to close, leaving its body above that area. Therefore, we classify this signal as false.
However, the subsequent pin bar pushes the price higher, causing the candle to close above the resistance area. This is a genuine breakout signal, especially enhanced by the presence of a strong, saturated breakout candle.
Trading Breakouts:
Trading market breakouts carries inherent risks due to the prevalence of false breakouts, which are statistically more common. Therefore, it is extremely important to understand the market structure and monitor the movement of prices to the appropriate level.
Markets operate in cycles, moving between trending phases and periods of consolidation. The duration of market consolidation correlates with the strength of subsequent breakouts and subsequent trends.
Prolonged consolidation periods are not only observed by you, but by traders worldwide. Among them, some opt for trading bounces from levels, while others prefer trading breakouts. Extended consolidation behind a resistance level can trigger stop-loss orders for many bears and prompt numerous bulls to initiate new buying positions. Consequently, after prolonged periods of flat movement, prices frequently surge explosively following a breakout, ushering in a robust trend.
The breakout trading strategy offers multiple entry approaches, allowing traders to select the one that aligns best with their preferences and objectives.
Entering the breakout after the price has consolidated beyond the zone:
One strategy assumes that the breakout occurred when the candle closed outside the level. While this pattern can be effective, I personally find it risky due to the many nuances associated with this strategy. Instead I prefer a different approach...
Breakout entry with retest:
This tactic is a bit more challenging as it requires patience and discipline.
What particularly appeals to me in this strategy is that I rely on additional data during a potential retest (with a 60-70% likelihood after the zone is breached).
Breakout of the symmetrical triangle pattern:
As the market tightens its consolidation, it eventually breaches the support of the triangle, followed by a retest of this level as new resistance.
For the stop-loss placement, it's advisable to position it inside the triangle above the breakout candle.
Regarding take profit, we target the nearest level, ensuring the risk-to-reward ratio remains acceptable.
Best Breakout Trading Method:
Accumulation of positions/liquidations - consolidation.
When a tight consolidation occurs near a resistance level, it tells us that buying pressure remains high for a long period of time and sellers do not have enough strength to reverse the price from the level.
When the price breaks through a resistance level, traders with short positions cut their losses. At the same time, the pressure from buying traders who will open breakout transactions is increasing. All these factors cause the price to rapidly move up without significant pullbacks.
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I have only covered a portion of the basics. Of course, trading involves various elements such as price action, indicators (divergences), but that would make this post too long ;)
If you enjoy my educational articles, please leave comments, and I'll continue writing them.
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