15.1 What are Breakouts?

What are Breakouts? - Text Version

What are Breakouts?

Hello, and welcome to our course on breakouts! In this first lesson, we are going to explain what a breakout is. In future lessons we’ll go on to explain how to exploit them to make profits in Forex and other markets.

So, what is a breakout? In general terms, a breakout is what happens when the price has been contained within a range and then leaves this range with a strong directional move. Let’s look at a real-life example to see what a breakout looks like. Between the October 3^rd and December 19^th 2018, the USD/JPY currency pair traded between a high of 114.55 and a low of 111.37. The price was contained within a range of just over 300 pips. Then on the 20^th of December, the price made a strong downwards move and broke below the low of 111.37. The price literally “broke out” of this range. Over the next 8 days, this strong downwards directional breakout continued, with the price falling by another 662 pips to reach a new low of 104.66. This is a classic example of a breakout.

We said that a breakout is what happens when the price leaves a range with a strong directional movement. If you think about it, this means that there are breakouts going on all the time, on different time frames, and that there is a subjective element to identifying a potential breakout. A breakout can be as simple as a price making new highs or lows. However, we can apply some rules that will help us to identify which breakouts are more significant and therefore more likely to be a source of profit.

Rule 1: Breakouts on higher time frame charts are more important than those on lower time frame charts. For example, the price making a new 50-day high is far more significant than the price making a new 50-minute high.

Rule 2: The narrower the price range and the longer time the range has held before the breakout, make it more likely that the breakout will be strong. For example, if the price stays within a 300-pip range for 100 days, the subsequent breakout will probably be stronger than if the price had remained within a 500-pip range for 20 days.

Rule 3: A breakout where the price advances to relatively long-term highs or lows is likely to be stronger than one where the price breaks to shorter-term highs or lows.

Rule 4: How the price behaves after the breakout finally happens is a good indicator of what will happen next. If the price stays beyond the breakout point for some time, the directional movement is more likely to continue. For example, let’s say the price of EUR/USD breaks above 1.1000. If the price remains above 1.1000 for a couple of days without dipping back into its old range, this suggests the directional upwards movement is more likely to continue.

In this lesson, we have outlined how to define breakouts and explained some rules that can be used to assess their quality. In the next lesson, we will present some historical data to show why trading breakouts is a statistically reliable way to make profit in Forex markets.