Are False breakouts a form of trickery?
False or Fake breakouts are terms used in technical analysis when referring to asset prices that break out of the projected support-resistance lines or trend lines. In normality, when a price breaks out, it continues in that specific direction. However, if a price breaks out in opposition to an investor’s trade order and returns back to the projected course, the requested trade order would be regarded as a false breakout.
Note that in false breakouts, traders with open stop loss orders could take some damage as the breakout was indeed misleading, making traders automatically cut loss when prices reach their designated stop loss point. However, on such occasions, prices tend to reverse back to their original state, making traders lose out on profit opportunities.
False Breakout examples
In this example, the graph indicates that the price made a breakout from the neckline of the chart pattern in an inverted head and shoulder movement, which can result in reversals in the market.
However, such indications can be false signals that occur when a graph reaches a certain high point and falls downward, bypassing the neckline once again, returning to its initial downtrend motion.
False Breakout types
False breakouts can be divided into two main categories, in accordance with their breakout motions:
Bull Trap: a false breakout characterized by breakouts through the set resistance line into an upward motion, but returns downtrend.
Bear Trap: a form of fake breakouts that falsely indicated downtrend movement as the price graph has bypassed the resistance line downward, but returns up to an uptrend motion.
Avoid risks from False Breakouts
Avoiding false breakouts as a whole is impossible. What traders can do is manage risks by using various tools and indicators. A means of administering situations can be waiting out potential false breakouts and requesting trading orders at suitable points, which can be after studying candlesticks or a larger time frame to confirm various price movements.
An additional method is to observe the market volume, in collaboration with the use of the Dow Theory, which partially explains that; “volume must confirm the trend.” Therefore, if a market’s volume is high enough, chances are, the breakout may not be false.
Nonetheless, some particular moments can indicate abnormally high market volume, which can mislead traders to believe that breakouts are indeed confirmed.
Other than the aforementioned, risk management is one of, if not, the best method in trading with discipline, while also consistently assessing risks through pragmatic strategizing.
A widely-used strategy to handle situations is to stop loss, even if it may be due to false breakouts. However, if it is indeed a real breakout, stopping one’s loss may have been the best means of mitigating risks and damage. On the same premise, taking profit is also a popular means of stopping any harmful risks towards one’s assets.