In Price Action Patterns

Consolidation is the result of indecision and lack of conviction of the consensus of traders across the globe. Cyclical patterns develop, which at one point or another, get busted.

I though I would write up a quick post to address some of the bigger issues I see traders struggling with in order to determine whether to fade a level or trade right into it.

In the 1-2-3 Breakout Pattern, we look for matching highs or lows with corresponding higher lows or lower highs, respectively. But many times, our breakout level isn’t so clean, and there is a support or resistance range that keeps on getting knocked into, and price fading.

For example, in the chart below, EUR/USD took a lot whacks at the top of this zone before eventually, it broke right through it.


When it comes to trading breakouts on ranges, in a nutshell, the following are the major ingredients I’m looking for:

Key Ingredient #1 – The lowest level

You want to enter the position before the lowest level. The logic being here that should price decide to once again fade one of the higher levels, your position is protected from loss. If it’s going to break out, its going to break out. No sense in delaying the process or holding out on pips you could be making.

Key Ingredient #2 – Momentum

We want a forceful breakout, not one that dwindles around the level yet again; if we’re not getting one, then something is wrong. We want price to spike hard and fast, shooting right for the highs of this range and of course, breaking out of them. There has to be a clear, intentional violation of the range as a result of overwhelming bids or offers.

Key Ingredient #3 – Higher lows or lower highs

This concept carries with me in pretty much everything that I do. It’s the first thing I look at every day. I want to see which direction the cyclical market waves are leaning towards. To do this, just imagine a 1 period moving average running through price, and looking at the macro direction of the wave.

In the case of a breakout to the upside, you want to see the last 2 or more major waves making higher lows. In the case of a downside breakout, the last 2 or more major waves making lower highs.

Bonus Ingredient – Mini Fade right before the breakout

If price has already raced up to the level by a substantial amount, you’re likely to see profit taking along the way. This is going to slow down price and decrease the chances of gaining the momentum we are looking for. Therefore, you will oftentimes see a ‘mini fade’ right ahead of the level. Not only does this give you some adjustment ad decision time, but a better shot of a clean entry immediately before any type of breakout.

IF you follow the above and all conditions are met, you’ve got a good trade. If you sacrifice some of them or simply get overzealous, I think it’s rather obvious what could occur.

Entries:

Entries should be taken ahead of the level getting hit, not after. If you’re entering after the fact, you’re chances of being able to split your trade to breakeven go down substantially, and you could end up risking more than you bargained for. When you see price approaching a level, watch it closely, and go for it, should all of your criteria line up.

Timing is key on these types of trades. Just as with a baseball or cricket player, the swing of the bat, if too early or too late, isn't going to put the ball on the intended course. The same could be said about these trades as well. Screentime and simple observation of numerous past breakouts can boost your confidence, however. Whenever I feel unsure of something, my first reaction is to simply look at past examples. Having them in my short term memory reinforces what I am doing in the ‘here and now'.

In terms of stops:

Stop losses shouldn’t need a lot of room on these trades, should you enter correctly. It’s either going to fade, or its going to breakout…..end of story. If you enter on spiking momentum right before the level gets hit, you shouldn’t be seeing much of any drawdown to speak of. Therefore, depending on the timeframe, relatively tight stops could be used when trading breakouts. Mine are typically in the 10-20 pip range on trades like these, and even at that, I can usually tell ahead of time if it’s going to fail or not.

Being adaptable

Just as important to note with this or any strategy is that oftentimes traders get married to either a contrarian or trend following mentality. In other words, they are trying to fade all the time, or play breakouts all the time. Getting married to one of these mentalities I believe degrades your quality for entry selection over time, as you become more comfortable with selection criteria you are likely to sacrifice some of the needed ingredients for higher-probability setups. Forcing yourself to remain adaptable and clearly be able to distinguish the difference between level breakouts and level fades is as important as any other factor stated here. Be careful, and stay on your toes.

Assumptions on past, poor experiences

Don’t automatically assume everything is going to be a breakout because you’ve been burnt on fades in the past, nor fades because you’ve been burnt on breakouts in the past. Follow the steps and use common sense, sound judgment and strict risk management, and you should be fine.

Overzealous trading kills accounts. If you don’t need to, or are simply unsure, don’t do anything at all. That’s probably the most basic, 101 risk management technique ever invented. But when the totally obvious no brainer crosses your path, spring for it, and don’t let it go.

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Showing 10 comments
  • fxlan
    Reply

    Yeah thats certainly something to look for. Thank you Steve for another great article!

  • zjjj
    Reply

    First class…this advise came just at the right time!

  • Darren
    Reply

    Great article. Thanks. I like the comment about the "mini fade right before the breakout".

  • kk007
    Reply

    Thanks Steve! Although a bit complex than other entries, good explanation!

  • Inzider
    Reply

    I never lost my time reading those articles!
    Simple, focus, quality writing!

    Thx Steve!

  • plukin
    Reply

    "being adaptable" hmm, that's the problem not only here :). Easier said then done.

  • Andy
    Reply

    I always err on the side of caution on breakout trades. The article sets out very clearly how to stalk a 123…x BO. I might add a small small tip to the recipe. When PA finally makes its push past the level move to break even as quickly as it sensible.

    This should be a safe thing to do, you are expecting a strong move away from the level; if you do not get this BO price behavior you are expecting then you will want to have your position at break even as quickly as you can.

    If you entered at the optimal 'early' level then you should feel comfortable that price will not spike you out and you should avoid any small bounce before price moves off.

    I have also observed a number of 123…x BO's will provide a second chance (safer entry) with a small pullback/retrace to the level once pushed through, this is likely to be the result of stop losses being fired from those who were looking to fade the level.

  • ps
    Reply

    Stewe can you please write a paper about your rules (price action for BO and fail) in range boundaries?

  • Henry
    Reply

    Hi Steve

    May I know please what you meant by the lowest level in your statement “You want to enter the position before the lowest level. “? Where is this lowest level in the chart you showed?

    Thank you.

    Henry

  • Nathan A.
    Reply

    I agree especially with the last bit – you’ve got to be real picky when trading range breakouts generally speaking, A range by definition means the market is showing a tendency to bounce off of levels rather than break out. Price action can also be spiky both ways around a potential breakout level – so I agree with Steve on the necessity of getting a good clean break, or get the dickens out and manage your risk. The breaks that are not going clean can actually be very fadable for quick scalps. For folks like myself who get in and out quickly as deemed necessary – range fading can work well with careful/quick risk management. If you are in position on a fade where the market has been resisting a level, but is now beginning to push in/hold more aggressively against that level, you can often get out of the way with little or no damage with a careful eye and timing a manual exit(of course there are times you do not “time” your exit, but just scratch the trade fast) – but you must be disciplined to execute this. Also in a situation that warrants aggression, entering a fade quickly with half position size and then entering in again if price moves away a little more towards the level being faded can optimize entry – and even allow you to “roll over” a trade which exhibits signs that you may want to get out. Also, on a nice fade – you can put an in the money stop, and sometimes catch a nice run the other way.The risk reward on this can make up for numerous scratches. (Of course beware off getting caught when there is a serious breakout, your stop is likely to suffer some slippage)

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