MOST of the time, trading a breakout is a simple way to trade the markets. It was one of the first few techniques I learnt when I started to trade FX back in 2006 and, as a well-documented trading edge, it has been used for many decades. It is also a particularly effective technique when trends are strong.
The system is simple: it suggests buying an asset when its price is breaking out above a prior major price top. The reason for the breakout matters less, but often it’s because new fundamental news has reached the markets. Fresh announcements cause prices to rally to the new equilibrium given the unexpected news. And anyone trading the breakout wants to be part of this rally to a new equilibrium.
If the breakout happens on the 24-hour time frame, and is also motivated by a fundamental reason, this strengthens the likelihood of a genuine signal. People will usually enter when price takes out the old high, and then place a stop loss at the latest major low for protection if the breakout is false.
A breakdown is the mirror image of the breakout, but occurs when the trend is already negative and the price takes out a prior important low.
Breakouts can also be traded across shorter time frames. This is an integral part of the London Open Breakout – a technique for detecting the direction of price on the onset of every new trading day in the euro-dollar and many other currency pairs.
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Alejandro Zambrano is a currency analyst at DailyFX. He leads DailyFX’s Premium Educational Seminars – http://bit.ly/PremiumEDU