When trading breakouts in forex, it is essential to realize that there are two main types:
1. Continuation breakouts
2. Reversal breakouts
Knowing what type of breakout you are seeing will help you make sense of what is happening in the big picture of the market. Breakouts are significant because they indicate a change in the supply and demand of the currency pair you are trading. This change in sentiment can cause extensive moves that provide excellent opportunities for you to grab some pips.
Sometimes, when there is an extensive move in one direction, the market breathes. This occurs when buyers and sellers pause to see what to do next. As a result, you will see a period of range-bound movement called consolidation. If traders decide that the initial trend is the right decision and continue to push the price in the same direction, the result is a continuation breakout. Just think of it as a “continuation” of the initial trend.
Reversal breakouts start like continuation breakouts after a long trend; there tends to be a pause or consolidation. The only difference is that after this consolidation, forex traders decide that the trend is exhausted and push the price in the opposite or “reverse” direction. As a result, you have a “reversal breakout.”
We know by now you are super excited to start trading breakouts, but you also have to be careful. Just like Lionel Messi can fake out defenders, the market can also fake you out and produce false breakouts.
False breakouts occur when the price breaks past a certain level (support, resistance, triangle, trend line, etc.) but doesn’t continue accelerating in that direction. Instead, you might’ve seen a short spike followed by the price moving back into its trading range.
An excellent way to enter a breakout is to wait until the price returns to the original level and then see if it bounces back to create a new high or low (depending on which direction you are trading). Another way to combat fakeouts is by not taking the first breakout. By waiting to see if the price will continue to move in your intended direction, you give yourself a better chance of taking a profitable trade. The downside is that you may miss out on some trades where the price moves quickly without hesitation.