Crypto Trader: How to Trade False Breakouts
One of the Most Popular Crypto Trading Strategies is to Learn How to Trade False Breakouts
False breakouts are a common occurrence in the crypto trading market. It’s not uncommon for traders to enter a trade only for it to immediately move against them. Why does this happen? Often, because of "herd mentality" leading traders to sell at the bottom of a move and buy at the top.
But with a good understanding of the price action that comes before such breaks, you can not only avoid getting stopped but also profit from false breakouts. In this post, we define a false breakout, go over typical false breakout setups, and learn how to trade false breakouts with the trend.
What Is a False Breakout?
A false breakout can be defined as either of the following scenarios:
- A break that occurs below or above a prior candle but does not close below or above the candle.
- A break that occurs above or below an obvious level but quickly reverses that level and starts a counter-trend move.
A false breakout is, therefore, a market deception that tests an extreme level by breaking it but fails to sustain that break and retracts below or above that level. In simpler terms, the market fails to close outside the level tested, leaving behind a false breakout.
Type of False Breaks
• Bull and bear traps at significant market levels
This is a 1 to 4 bar pattern characterised by a false break, usually at significant market levels. Such false breaks are often preceded by substantial directional moves and happen when a market is approaching an extreme level.
When a market approaches a major level aggressively, traders assume that the level will break, so they buy or sell the breakout only for the market to reverse and form a bull or bear trap.
Bull traps tend to appear after a move higher. Inexperienced traders who all this time have been on the sideline watching the new movement unfold, cannot hold their patience anymore. They jump into the market near the critical resistance level, confident that the market has now gathered sufficient momentum to break above it.
The market then proceeds to break above the level and fill all the breakout orders just before the market pushes lower as the “market makers” come in. Amateur traders are left trapped in a long and losing position.
• False breakout of consolidation
These types of breakouts are common in the crypto trading market. False breaks of consolidation usually happen when traders are lured into believing a trading range will breakout, only for it to revere back into the range’s body. To avoid this trap, always wait until the market makes a clear close outside the trading range on the daily chart before you start looking for price action trading signals in the breakout’s direction.
• Inside bar false breaks / fakey’s
The fakey is a price action pattern with a false break of an inside bar setup. Once you spot an inside bar setup, you can watch for a false –break of the mother bar and the inside bar.
Trading the False Break Setup with the Trend
When trading with the trend, the underlying order flow is usually heavily imbalanced and, therefore, heavily bearish or bullish. As a result, false breakouts happen during such trades.
When a false break creates a counter-trend, it runs into those traders who are willing to take the pullback getting a better price.
Here is an example of a false break setup with the trend:
As you can see from the chart, there is heavy impulsive for selling, starting at the top left. The heavy selling leads to a bounce that hits the upper resistance level marked by two red arrows. After the trading pair forms a new low indicated by the red line at the bottom. The trading pair then bounces and retests the bears at the same resistance level.
The pair goes ahead to break the resistance level with a large blue bar and closes at the highs. This observation begs the question, "how come the bulls did not produce any follow-through if they were really in control"?
Any bull traders who were already long should have noticed that the next two Doji candles did not show any real strength or follow up buying. Any bear traders who wanted to trade should have been on the lookout for the close below and false break, which happened on the 3rd candle.
Entry, Stop and Take Profit
When the resistance level and trend as clearly defined, there are two main entry techniques: you can sell on the break that is back below the significant level or wait for the pullback setup to the major level.
If you are an aggressive trader with full confidence in your price action skills, you can sell on the break back below the major level. Although you might not get the best price with this technique, you might not get another opportunity to enter if the sellers come in hard on the false break.
Conservative traders are better off waiting for a pullback setup to the key level. If the major level and the false break are real, your trade should hold without going much into the negative.
Depending on the liquidity and volatility of assets, it's recommended that you place your stop trade order below the low, or above the high of false breaks by a few pips. Your first target should be at the end of the consolidation. If you prefer to go for multiple targets, choose the next support or resistance level.
So far, you have learned what a false breakup is, the different types of false breakouts, and the order flow behind a false breakout. You've also learned how to potentially profit from trading false breakouts with trends, how to place your stop loss, and when to enter the market.
You should now be able to read price action in real-time and have an easier time spotting false breakout setups. As your skills grow, you will learn to avoid most of the common traps and gain massive profits from trading false breaks. They are some of the best opportunities you will get when trading cryptocurrencies. Let us know if this guide has helped teach you how to trade false breakouts in the comments below.
Learn how to trade support and resistance levels.
Find out how to trade using stochastic indicators.
Learn about crypto margin trading.
About the author:
Jay Jackson is a blockchain enthusiast and a freelance writer at topcryptowriter.com. He works closely with brands (people, businesses and startups) in the crypto sphere. He currently writes Blog posts, Guides, Press releases, ICO reviews, eBooks & Whitepapers. You can find him on LinkedIn.
The above references an opinion and is for informational purposes only. Do not take this as personalised financial advice or investment advice. The views expressed by the author do not necessarily represent the opinion of BitPrime.
Last updated: 24/12/2019