How To Avoid False Breakouts

A false breakout happens when you draw support and resistance lines and wait for price to break through a level. The break does happen, so you open a trade based on it, and then you are surprised to see price move only a few points past the broken support or resistance line before reversing completely. This is what traders call a false breakout. In reality you have to get used to it and try to avoid it in every way you can, because it happens often and cannot be ignored. That is what we cover today: a very simple way to avoid the false breakout. See also our guide to False Breakout Strategy.

What is a false breakout?

A false breakout is the failure of price to keep moving after it breaks through a certain level.

More: Full guide to the false breakout strategy

How to identify a real breakout and avoid a false one

Watching our breakout trades fall apart in front of us is painful, and it is hard to decide what to do about open positions: do we accept the current loss and close the trade, or wait for price to move in our favour? To avoid this uncertainty in the future, we need to add a new rule to the breakout trading strategy, which is to wait for the candle to close above the breakout level. Look at the figure below.

As shown above, instead of executing a trade the moment price breaks a key support or resistance level, we should wait for the candle to close to confirm the strength of the breakout. So the idea of using pending entry orders above or below support or resistance levels to enter a trade automatically is not a good one, and it can lead us into the false-breakout trap, since price may reverse completely as soon as that order is filled.

Based on the above, here are five key tips on how to avoid the false breakout with more confidence.

First: set your plan and strategy and understand technical price patterns

No trader can know for certain how to avoid a false breakout. Many traders fall into the trap of analysing and predicting the forex markets, then are surprised when their plan does not work, and that is not how trading works.

Here you need to keep identifying the most probable path of resistance, which works as a strategy for avoiding a false price breakout. This requires regular updating rather than a fixed path. You should also realise that breakout setups occur after patterns and formations appear on the chart.

Second: wait for strong candlesticks at breakouts to avoid the false breakout

Measure the success of a breakout by watching the strength of the candle close. A strong candle close is when the candle closes near the high or the low. The following points show how a candlestick close works with a breakout setup:

• A strong bullish breakout is signalled by a candle closing near the high.
• A strong bearish breakout is signalled by a candle closing near the low.
• Another sign of strength is the candle size; a larger candle indicates a strong candle compared with a smaller one relative to the candles of that timeframe.
• Although candle size is one factor to consider, I personally think the candle close is more important.

Third: replace the break with the breakout to avoid the false breakout

Breakouts are traded on one large timeframe, waiting for the pullback and the continuation of the break. What I mean is that if the pattern is visible on a 4-hour chart, I move to a 1-hour chart and look for a smaller pattern forming on that timeframe.

When price forms a pattern strongly after the breakout, it signals that this is not a false breakout, because it shows that price is actually building a new correction after the momentum. This is a continuation signal pointed to by the market price psychology, and it lets you avoid the false breakout. So remember that these are the basic steps:

• Look for the chart pattern.
• Zoom in one timeframe.
• Wait for the breakout.
• Wait for a pattern on a smaller timeframe.
• Enter the next breakout.

Fourth: use trend lines, moving averages and indicators

Here you should answer some questions to avoid the false breakout:

• Is price moving away from the average or pulling back towards it? Moving away is a potential breakout, while the pullback represents a bounce.
• Is there a gap between the moving averages, or are they crossing each other? A gap between the short- and long-term moving averages indicates a trend, while moving averages with no gap between them indicate a range.

Trend lines matter here too, because they help gauge the chart pattern itself. Drawing support and resistance levels will also help us identify the pattern and avoid the false breakout; in fact traders need to see hundreds of patterns before they can start spotting them accurately.

The Envelope indicator is also one of the most important indicators whose bands are used to define support and resistance as a bounce or breakout zone and to avoid the false breakout.

Fifth: candle close and body above or below pivot levels

When using moving averages and trend lines, it helps to review the relationship between price action and the support or resistance level and the pivot levels, since the candle should close near the high or low of the level. Here are some of the most important points for avoiding the false breakout:

• The best breakouts happen when the candle closes above the moving average, trend line or pivot zones.
• The best breakouts happen when the candle body is above the moving average or trend line (50% is suitable).

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Frequently asked questions

What is the benefit of the trend?

As one of the most common trading methods, trend following has many advantages, such as low transaction costs and the ability to ride trends.

How does a trend start?

A trend in forex, the stock market, and so on is when the market moves up or down over a defined period. It shows whether buyers (an uptrend) or sellers (a downtrend) are in control.

What does breaking the trend mean?

Key takeaway: a broken trend line is a technical signal that can indicate a change in direction. If low volume, not high volume, accompanies the trend-line break, the signal is not strong or convincing. It may make sense to wait a day or two to confirm that the trend-line break is legitimate.

What is a false breakout?

False breakouts happen when price passes a certain level (support, resistance, a triangle, a trend line, and so on) but does not keep accelerating in that direction. Instead, what you might see is a short spike followed by price returning to its trading range.

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