How to be sure that a breakout is for real

FOR the past two months, currency traders have been wondering whether euro-dollar will manage to break through the $1.50 level. The pair has made several tests of this psychological resistance level but has so far been unable to consolidate any gains made.<br /><br />Jumping on board a breakout can be a highly successful strategy, but all too often traders fall victim to failed break outs &ndash; known as fake-outs. In the case of euro-dollar, the break earlier this week to above $1.5065 to fresh 2009 highs appears to have been a false break with the market sharply reversing course and trading back below the 50-day simple moving average.<br /><br />Investors can quickly find themselves on the wrong side of the trade as the market reverses and with losses stacking up. So how can you spot a real break through a resistance level?<br /><br />There are three factors to take into consideration when assessing whether a break out is valid and likely to be a sustained move.<br /><br /><strong>SUPPORT LEVEL</strong><br />First, the number of times that the currency pair has previously touched the relevant resistance or support level is often a good guide. The more times a stock price has touched these levels, the more valid they are and the more important they become.<br /><br />Second, look for chart patterns that would support a break out, such as channels, triangles and flags. These indicate a sideways-moving currency pair that is trading in a range. Usually, chartists will draw sloping support and resistance levels and a real breakout tends to occur about two-thirds of the way through these patterns.<br /><br />In contrast, the weekly chart of euro-dollar still shows the formation of a potential double top, says Joel Kruger at FXCM. &ldquo;The neckline comes in by $1.4625 and a break below would open a measured move decline towards the $1.4100s. As such, any rallies above $1.5100 should be used as an opportunity to establish short positions,&rdquo; he adds.<br /><br />And finally, it is often better to wait for the initial move before entering the market. You should consider whether the volume associated with the breakout is sufficient.<br /><br />If there are only thin volumes, then it implies that the move is not supported by the wider market and is at risk of breaking down. If market volumes surge, then you are less likely to find yourself on the wrong side of the trade.