As an options trader, you probably know about using trends to determine when to enter and exit trades profitably. Trends are a good way to constantly make profits without making huge risks.
The problem is, identifying a trend could take a long time and profits earned on this type of strategy could be minimal.
There are other trading strategies available. One of the strategies commonly used by professional traders is the breakout strategy.
What is the breakout trading strategy?
This is a trading strategy that’s based on high price fluctuations. For example, say you’re following a certain currency pair’s price movements over several hours.
From your analysis, you notice that the price rarely rises above a certain price point. It also doesn’t drop below a certain price point.
The former is usually termed the resistance price range while the former is called the support price range. Then all of a sudden the price suddenly rises above the resistance price range or drops below the support price range.
This trend continues for a certain amount of time. The time at which the price rises above the resistance or drops below the support price range is called the breakout. Thus the breakout strategy is focused on identifying breakouts in trends and profiting from them.
How do you do this?
You’ll obviously identify a breakthrough when it occurs. It’s usually identified by an extra long candle that signifies sudden price fluctuations over a short amount of time.
The candle closes well above the resistance or below the support level. Once you’ve identified the breakthrough point, your job involves predicting how long the price will rise or drop. This way, you can easily enter and exit profitable trades.
There are two ways I usually use to identify a breaking point.
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1. Identifying breakout point using support and resistance price points. When using candlestick charts, you’ll notice that price movements tend to remain within two price points for extended periods of time.
That is, the prices rarely go above or below certain price points. The upper price point is the resistance while the lower is the support level.
However, the prices will regularly move above or below these price points.
At this moment, you’ll notice a bold and large candle that closes above or below the resistance or support respectively.
The point at which the price movement suddenly changes is the breaking point. One thing I’ve noticed while using the breakthrough strategy is that once the break point is reached, the prices will continue rising or dropping for a certain amount of time before the trend reverses.
This is the time to enter position and make a profit.
Note: An easy way to predict breaking points is by keeping a keen eye on the resistance/support levels. Once the price inches closer to either of these levels, keep an eye on the volume. If volume is high, it’s likely that there will be a breaking point.
2. Using the trading range to forecast an upcoming breaking point. At times, I will use the trading range to try and predict when a breaking point is likely to occur.
The trading range is simply the difference between the resistance level and the support level. As mentioned before, price movements tend to remain within a certain range for sometime before a breakthrough occurs.
This strategy has it’s shortcomings the most common being fake breakthroughs and the price suddenly falling back after the breakthrough occurs.
Some of the rules professional traders follow when using this strategy are:
i. If the trading range lasts long, the probability that the breakthrough will be significant is high.
ii. If the trading range is narrow, breakouts tend to provide reliable and profitable signals.
iii. When a breakout occurs, it’s better to go long or initially wait to see whether the trend suddenly reverses.
iv. When using the breakout trading strategy, place your stop loss somewhere below the breakout candle. This minimizes losses in case the breakout was false or price movements suddenly reverse.
Here’s an example trade using the breakout strategy on the Olymp Trade platform
I’m going to use the USD/EUR currency pair for this example. The reason why I prefer to use currency pairs is their volatile nature. As such, the possibility of breakouts occurring often is quite high.
1. The first thing I’ll do is change the chart to the Japanese candlestick.
2. The next thing I’ll do is identify the resistance and support levels.
3. Third, I’ll keep track of the price movements until a breakout point occurs. In this case, the price rallies above the resistance level. I make a buy and time my trade for 30 seconds.
4. At the end of the 30 seconds, the price is still rising so I make my profit. Sign up for an Olymp Trade demo account today and get $10000 to trade with!
Things to remember when using the breakthrough trading strategy
1. Your main goal when using this strategy is identifying the breaking point. That is, when the price moves above or below the trading range. The breaking point is where you’ll enter into a trade. Besides trade entry, you’ll also need to predict how long the price will remain above or below the breaking point. This allows you to make bigger profits and minimize losses.
2. Breakthrough trading works best in active markets where supply and demand constantly changes. I usually recommend it for FX currency pairs and cryptocurrencies. General Risk Warning! your capital may be at risk