How to trade false breakouts, the most popular crypto trading strategy
Trading false breakouts is one of the most popular crypto trading strategies out there. Its greatest advantages are considered to be the precision and efficiency, both of which are due to specific elements of this strategy. In this blog post, we take a closer look at the false breakout strategy and how to best utilise it.
Structure of the false breakout strategy
Whether we are talking about a breakout from a specific range, a triangle, trend line or simply any chart pattern, the basic idea behind a breakout strategy is to capitalise on a big move following a specific pattern. For this reason, failed breakouts are so popular to trade as you have a great deal of interest on both sides of the trading range.
One one side, crypto traders are looking for a breakout and a confirmation that the price action is continuing in the same direction. On the other hand, another group of traders is taking a closer look at the price action to gauge the market’s reaction as the price hits an important level, the one which bulls/bears are trying to break.
In general, there are three main conditions that define a successful breakout:
- Closing price - Failed breakouts mostly happen on higher time frames. For this reason, you would want to wait for the candle to finalise its formation before engaging in trade. If the price is above/below the pivot point, it doesn’t necessarily mean that it will close there. Therefore, always wait to see the final shape of the closing candle. Many crypto traders, especially those who aren’t scalpers or day traders, wait for the daily candle to shape before entering a trade.
- Volume - Arguably the most important element of the three listed here. Breakouts that are followed by a decreased volume will most likely result in a failed breakout. Always check the volume bar to verify the legitimacy of the breakout.
- Time of the day - The majority of successful breakouts occur during the busiest hours of the daily crypto trading sessions. News, data, or other fundamental elements tend to facilitate bigger moves in both directions. On the opposite, false breakouts mostly occur during the “laziest” hours of the trading session.
How to Trade a False Breakout
The Bitcoin price chart below showcases the perfect example of a false breakout. First, we have a clear high in place, where the price action stopped before rotating back lower to consolidate and find new buyers. In its second attempt, the price marginally took the previous high out. However, the price quickly reversed lower.
In this particular example, we see that the breakout failed to meet all three conditions outlined above. Firstly, the BTC price didn’t manage to close above the previous high, despite the fact it marginally created a new high. As soon as it briefly traveled north of the previous high, it rotated back lower, just to finish below the horizontal resistance.
Secondly, the volume behind this move was decreasing. This condition is also closely connected to the fact that this move occurred during the Asian trading session, when the vast majority of US and European traders are not yet fully active. So, the low volume indicates that the move is likely to fail.
All in all, all three conditions point to the fact that we have a false breakout on our hands. The million dollar question is: How do we make profits? As we outlined at the beginning of this blog post, false breakouts are popular as they offer precise levels to work with.
In this particular case, the previous high should be utilised to define the stop-loss order. Of course, always leave enough room for the price to move a bit higher without triggering your stop loss. Depending on the time frame that you trade, use a 10-20 pips cushion to protect your trade.
On the other hand, the take profit order is also fully dependent on your trading style and approach. You may want to scalp and look for the first immediate support for bulls, or simply look at daily pivot points and where the price action may pause or find support. For this reason, traders use different technical indicators - moving averages, Fibonacci, horizontal and diagonal trend lines etc. There is also another option, and that is the one where a crypto trader may also leave the take profit order open and modify the target based on the live market price.
Profitable crypto trading strategy
False breakouts can be profitable setups when you know how to trade them. In this blog post we defined the three critical conditions for verification of the legitimacy of a breakout. In case the breakout is likely to fail, a viable trading opportunity may be present. As always, set stop loss and take profit orders based on your trading style and risk tolerance.