Many traders spend a lot of time looking for potential breakout situations when trading the forex markets. This is because when these breakouts occur, they very often yield a lot of points. Here we discuss three simple trading strategies designed to catch these breakouts.
The first method makes use of Bollinger Bands. This technical indicator is very useful in displaying areas of support and resistance, which are marked by the two outer lines of the Bollinger Band range. Therefore, when one of these outer limits is breached, you very often get a breakout, in the same direction.
So, to trade this breakout, you would ideally want to wait for a period where the outer lines of the Bollinger Bands indicator have narrowed, because this indicates a period of tight consolidation. To put it simply, this means that a breakout will usually have momentum when it does break out of this tight range. Then, when the price does break through one of the outer lines, you can either jump in straight away or wait for a pullback to a short-term Exponential Moving Average, for example, for a better entry point.
The second method you can utilise involves using multiple Exponential Moving Averages (EMA), in particular the 5-, 20- and 50-period EMA. You may also like to add the 100- or 200-period EMA to your chart.
Then you simply wait until all of these indicators have flattened out and are trading very close to each other, along with the price. Then you wait for the shorter-term EMA, i.e. the EMA (5) to break out strongly from this narrow range, before taking a position in the same direction as the breakout and close to the EMA (5) for maximum value.
Finally, you can use a price-based system to trade breakouts. There are various ways you can do this. The simplest systems involve waiting until the price has started trading in a very narrow range, and then taking a position when the price breaks out of this range.
Another common system involves noting the high and low points from the previous trading day and then waiting for the price to break out of this range the following day. Indeed, this can be a very effective way of trading the major currency pairs.
In summary, there are a few methods with which you can trade forex breakouts. Of course, like all trading methods, none of these would work 100% of the time, so you will need to adopt a good stop-loss strategy.
In short, support levels are considered levels at which price declines are continually rejected. Conversely, resistance levels are considered levels at which price increases are continually rejected.
Traders looking at support and resistance levels in conjunction with one another are essentially examining what is referred to as a channel. It is very common to see price trends within the bounds of trading channels, meaning that for hours or even days at a time, a currency may trade within the bounds of support and resistance levels. Many times throughout a trend the price may test either the support or resistance level, but ultimately if the price is to remain within the channel, the support and resistance levels will be tested, but not pushed through.
Just the opposite of what is explained above: if a support or resistance level is tested for hours or days on end without a breakout, and finally the price does push through the bounds of this channel, it may be considered a strong indication that the price will take on an entirely new direction or trend.
Traders watching support and resistance levels are generally looking for one of the following trading opportunities:
A chance to buy – after the support level has been pushed, but not broken through several times. The trader's entry would likely be at the end of a strong bullish candle that began with a touch of the support level. The alternative scenario is a chance to buy after a previously tested resistance level is finally pushed through with a strong bullish candle. In other words, buyers in the market have tried numerous times to push prices above a resistance level, yet have failed. Finally, prices break through in the form of a strong up-candle, indicating that buyers would finally have their way and push the price higher.
A chance to sell – after a previously tested support level is finally pushed through with a strong bearish candle. In other words, sellers in the market have tried numerous times to push prices below the support level, yet have failed. Finally, prices break through in the form of a strong down-candle, indicating that sellers would finally have their way and push the price lower.
Fibonacci retracement is a very popular tool among technical traders and is based on the key numbers identified by mathematician Leonardo Fibonacci in the 13th century. However, Fibonacci's sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series.
In technical analysis, Fibonacci retracement is created by taking two extreme points (usually a major peak and trough) on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels. Before we can understand why these ratios were chosen, we need to have a better understanding of the Fibonacci number series.
The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum of the two preceding terms, and the sequence continues indefinitely. One of the remarkable characteristics of this numerical sequence is that each number is approximately 1.618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies.
The key Fibonacci ratio of 61.8% - also referred to as "the golden ratio" or "the golden mean" - is found by dividing one number in the series by the number that follows it. For example: 8/13 = 0.6153, and 55/89 = 0.6179.
The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example: 55/144 = 0.3819.
The 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For example: 8/34 = 0.2352.
For reasons that are unclear, these ratios seem to play an important role in the stock market, just as they do in nature, and can be used to determine critical points that cause an asset's price to reverse. The direction of the prior trend is likely to continue once the price of the asset has retraced to one of the ratios listed above.
In addition to these ratios, many traders also like using the 50% and 78.6% levels. The 50% retracement level is not really a Fibonacci ratio, but it is used because of the overwhelming tendency for an asset to continue in a certain direction once it completes a 50% retracement.
There are no strategies that can guarantee you positive returns in every trading scenario. Furthermore, not every trader wishes to use the same strategy in the same way and may have their own set of constraints in terms of: (i) the time that they wish to be in the market, (ii) the size of positions they can hold, and so on.
As such, it is worth repeating that each trader is ultimately responsible for the strategies that he or she adopts. With this in mind, we have provided a list of common strategies for you to research at your leisure.