Technical Analysis – How to recognise false breakouts

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Part 30: Technical Analysis – How To Recognise False Breakouts w/ Examples

I believe that this is not the first article you are reading on this subject. Anyway, before I start I should mention that false signals are part of trading, which you surely know. Sometimes you watch an important support or resistance zone and eventually you see a breakout. You react by taking a position but, all of a sudden, the market turns. So, you close your position and continue to wait. The market toys with you and sometimes pushes you out.

Note: This article is more detailed than usual and, compared to our standard articles, somewhat longer. However, I believe that it will be to your profit. So, let’s start on how to minimize losses caused by false breakouts.

When and why false breakouts occur

Usually, your chart identifies important support and resistance levels. These levels represent points where you should expect a reaction of some kind. If the level is very strong, one can expect that the market will bounce. However, what if it breaks? Is it a false signal or an opportunity for a great trade?

You can never be absolutely sure whether this is a serious (real) or false breakout. Anyway, if you have read about how big players can manipulate the market you know that one can never be sure. There is no certainty in the forex market or in markets in general. You already know that sometimes having a logical idea and odds on your side will do.

Support and Resistance

There are several important zones in each market, which you should mark graphically. Typically, these lines include trend lines, local support and resistance lines, pivot lines, or initial balance. Obviously, the chart also shows a double high/low and other important formations.

Draw all support and resistance lines in your chart, be it based on price action, Fibonacci sequence or any other indicator. Don’t forget that you want to see the lines on all time zones. For instance, from the yearly perspective it may seem that the market did not react on a support or resistance level but from the 15M or 5M prospectively you will nearly always see a reaction offering one or multiple profitable trades. Based on the above, it is necessary to see the lines on all time zones.

How to recognize false and real breakout

Instead of beating about the bush, let’s go ahead to breakouts. Support and resistance levels are already drawn in your chart, the price is approaching and a breakout follows. What to do now?

Tolerance Zones

Use Tolerance zone. Don’t trade a breakout by just one pip. Your support/resistance lines in your chart might not have been drawn exactly. Especially, when the trend line is long, a series of small deviations will result in a deviation that is much bigger. Anyway, even if your lines are drawn most accurately the line might be tested and a breakout of one pip can’t be regarded as a real breakout.

Your Tolerance zone depends on the timeframe you trade. With one-year support, it will surely be bigger than 30M. The instrument you are using is relevant too – the range might be roughly from 3 to 30 pips. By definition, a real breakout is when the market overcomes our drawn support/resistance lines including the Tolerance zone.

Some traders wait until the candlestick closes below support/above resistance line (i.e. the Tolerance zone determines the closing of the candlestick in a breakout). However, there are more options than that, for instance, trading of an already confirmed throwback (pullback).

We have said that a Tolerance zone of a few ticks or another confirmation of a breakout is a fundament. This is demonstrated in the below picture. Significant minimum generated strong support. This line was later tested and, as shown in the chart, the support line was broken by a few ticks. As you can notice, in the end, this breakout turned out to be a false one and the market made a turn.

It would have been better not to trade this breakout. Always reserve a space for a “Tolerance zone”.

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Even a strong support line might be conquered by a few points. This is clear proof that blind trading of support/resistance is not worth it. Any action requires some logic in the form of one more confirmation or at least a Tolerance zone. Also, ADX or declining trading volumes may protect you from a false breakout.

Small and big players

Big players face one problem: the amount of money they possess is too big. A market is a place where supply and demand come into game. If the big players want to buy more than the market is able to absorb they won’t find a counterparty. The reason is simple: excessive demand will push the price up to a point at which the big players will no longer want to trade.

Big players can see the same chart as you do know that stop losses or waiting orders tend to occur near important S/R lines. The number of the orders can’t be ignored and therefore, they decide to use them for making an order on their own. In a case like this, a false breakout may occur – in fact, initiated by the big players trying to receive profit from their stop losses and realize their enormous order volume.

A frequent problem the big players are faced with is capital volume. Look at the chart below to see how they manage such a situation. Moving sideways, they accumulate capital in small portions to create strong support which the later break, receive profit from the stop losses and invest the rest of the capital. This is an Exemplary move.

False breakout and sweeping of profit from stop losses. We recommend you read our article on the big players.

Price action

I admit that I personally prefer price action but I will show you indicators as well. To me, the first and absolutely crucial factors when watching the levels is tolerance. The situation now is much better than in the past. I remember times (5 – 7 years ago) when it was normal to see different prices offered by individual brokers and even different prices of platforms of two traders with the same broker. Even though the situation has improved significantly, you must allow for some tolerance, delay in calculation etc. I regard everything that happens within a 10-pip range from the drawn support/resistance line as a touch on the support/resistance level.

In other words, if I wanted to trade breakout I would take as breakout trades within the range of 10 pips. So, when trading breakout I don’t recognize a narrower range than 10 pips above a significant level. You may find this an obsolete practice (used when the data was not so accurate) but still in use because some small deviations may occur today, as well.

You should always confirm each breakout of a level. Prior to that, take it as if it was a false one. Typically, you wait until the candlestick gets closed halfway the breakout level. If the breakout leaves behind just a shadow (wick) it’s going to be a pin bar and one more strong price-action parameter. The pin bar will play in favor of a false breakout.

Taking a look at the chart may be enough to get a hint. Do you see a typical graphical formation? Or just a pin bar? If you do, be careful as long as the formation faces the breakout and the breakout is coming. I would consider reserving a larger tolerance zone or skipping this trading opportunity. On the contrary, if a price action confirms the breakout this is a good signal to trade.

It sounds too vague but it’s true: each trade is different. I personally found the aforementioned pin bars a very useful tool. If you don’t know what pin bar is read more here.

Typical false breakout with pin bar

In the above picture, you can see a typical false breakout with pin bar. An Exemplary example, indeed. If you wait until the candlestick gets closed above an important level you don’t enter the trade On the contrary, taking a short position following the pin bar was a tempting option.

As far as price action is concerned, it is worth repeating terms such as throwback and pullback. A pullback occurs when the price breaks below support, retraces back to support, which however now begins to act as resistance and rebounds from it, continuing its downward movement.

With this price action, watch the closing of the market and don’t trade the first incomplete breakout (it may later turn out to be a mere shadow), choose a tolerance zone and repeat the basic technical formations. I have one more rule to add: I trade the same level only once for a certain period of time. So, taking a long position based on a signal turning out to be a false one cannot happen to me. What I would do is close the position, open a new one – this time in the opposite direction – and, finally turn it back. A few false signals coming from the market may lure you into the above trap, which is why it is worth establishing a similar rule (I personally give myself one day for each important level. If the trading on the day is losing I no longer take the level into account).

The example below shows a resistance level that was conquered by a few pips and then broken. Tolerance zone would filter off the first false breakout, so you could trade the second one, which is aggressive enough. The tolerance zone has been broken. Taking a position will pay off even if you wait for the closing of the candlestick above the resistance. The closing of candlestick above resistance (or below support) is often criticized since the market may move too much. On the other hand, it is wise to wait for a throwback and then take a position.

A large candlestick in the breakout direction often confirms its validity

Take a look at the below picture. Nothing may play in favor of the big players; you still can use the tolerance zone. Confirming breakout may occur on a lower timeframe, still generating a false breakout. This may happen too and it is part of trading. Your trading strategy surely anticipates some losing trades. Remember, these are things you can never avoid, however, you can minimize them. Same as a large candlestick confirms a breakout, a large candlestick in the opposite direction will confirm a rebound.

Rebound from resistance confirmed by a large candlestick pattern.

Trend or stagnation

If you correctly analyze the market you will find out that most of the time the market moves sideways i.e. stagnates. Even long-term trends may suffer trend moves followed by long sideway moves. What is the difference between trend and stagnation?

If you follow a trend it is important how strong the trend is. It’s wise to watch volume indicators and the speed of the moves. If the moves are aggressive it may signal an approaching breakout followed by the trend taking a second breath. If, however, it is a long-term slow trend you may expect at least some slowdown at an important level – so be vigilant with the breakout.

If the market stagnates, it’s likely that instead of a breakout it will rebound. The reality is harsh, the change in the direction of the trend is inevitable. Be careful and have the breakout confirmed!

How to recognize a false signal using indicators?

Filtering false breakout thanks to stochastic oscillator

Paying attention to the stochastic oscillator, typically the 80-20 range, and the intersection that may indicate a trend reversal is a useful thing. Another good indicator (conditioned by your trust in the data from your broker) is volume. If the volume grows the breakout is going to be strong, the opposite attests to a false breakout. Frequently used are also ADX and RSI.

If you add stochastic oscillator (indicator) to the above chart you can see that it signals a trend reversal. So, according to the indicator, you should not trade the breakout.

I already mentioned the fact that when it comes to indicators I don’t like delay. You are constantly one candlestick behind and don’t fully see the presence. When used in a back-test, indicators do a great job but in real life, it’s worse. Saying this, I don’t want to put you off. On occasions, I use the indicators too. However, be careful. Let the candlestick slowly close and analyze all that has happened in the market. Don’t get distracted by the current candlestick. It may turn out to be a very good helper. It always begs the question if it’s not too late to use an indicator. I recommend that you combine both methods.

Using RSI and MACD indicators

False breakouts of forex and other markets can be filtered out by using the aforementioned methods. If you prefer trading with indicators it is worth watching MACD or RSI (to see potential trend reversal on MACD or overbought/oversold at 20 and 80 levels on RSI).

How to recognize real breakout

The screenshots can serve as the demonstration of a typical breakout. Notice that even waiting for closing the candlestick in the second half below, an important level, allows you to enter the trade (short position in our case) and to earn a decent profit. The first screenshot illustrates the market, the second one, more detailed, includes an indicator.

Exemplary breakout 2 (in detail)

An opposite to recognising false signals is confirming rebounds. This topic is covered on our website by the following articles:.

Author

More about the author J. Pro

Unlike Stephen (the other author) I have been thinking mainly about online business lately. I wasn’t very successfull with dropshipping on Amazon and other ways of making money online, and I’d only earn a few hundreds of dollars in years. But then binary options caught my attention with it’s simplicity. Now I’m glad it did because it really is worth it. More posts by this author

2 Responses to “Part 30: Technical Analysis – How To Recognise False Breakouts w/ Examples”

I am very thankful to you for sharing such a comprehensive technical analysis you have shared through this post. It even gets more easier for me to understand with the example and the case study you have shared!

I really appreciate your efforts

Hello, we really appreciate your feedback, thank you so much.

We hope that you will learn a lot of useful tips from our technical analysis show.

False Breakout Strategy: A Simple Yet Powerful Approach

Consider the following scenario.

You’ve had EURUSD on your watch list for weeks. More specifically, you’ve been waiting for a break below a key support level to take advantage of the selloff that’s sure to follow.

After three weeks of practicing saint-like patience and unshakable discipline, the Euro finally sells off against the US dollar and closes below support.

The wait is over!

You open your trading platform, enter the necessary details of the trade and place a limit order. Before you go to bed, you work out what the profit will be one last time out of sheer excitement.

The following morning you awake to find that not only did EURUSD fail to respect former support as new resistance, but it also rocketed 200 pips higher against the USD taking out everything in its path including your stop loss.

The pair goes on to close the day back above your key level, negating the entire trade idea as well as your bearish bias.

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Sure it does. We’ve all been there. Even the best looking trade setups can and do fail on occasion.

But the million-dollar question is, why did this happen?

Better yet, how could you have mitigated the risk or perhaps even benefited from the false break itself?

That’s what you’re about to learn. By the time you finish reading this lesson, you will have a firm understanding of what false breaks are, why they form as well as how to take advantage of them.

Read on to learn about this little-known trick.

What is a False Breakout?

First things first, before you can learn how to use false breakouts to your advantage, you have to know what they are and how to identify them.

A false break, or breakout, as the name implies, is any move (and subsequent close) above or below resistance or support respectively followed by a reversal that fails to respect the broken level as new support or resistance.

Let’s take a look at an example.

Notice how NZDJPY closed above channel resistance on a 4-hour basis but subsequently failed to hold above it as new support.

What’s important to note here is that we’re dealing with closing prices. If a currency pair merely pierces a critical level, it is not considered a false move.

For example, I see a lot of traders incorrectly labeling the two instances below as false breaks.

Whether you consider these false breaks depends on how you define a “break.” For me, a breakout requires the close of a candle, and because I trade the daily time frame 90% of the time, it often involves a daily close above or below the level in question.

If we revisit the EURGBP chart above, the daily candle merely pierced resistance, so to label this as a false “break” is inaccurate as the candle never actually broke (closed above) the key handle.

Now, if you had been trading the 15-minute chart, the decision about whether or not it’s a false break would have been different. Having said that, the technique I’m about to show you is only accurate when used on the higher time frames such as the 4-hour and daily charts.

There is often too much “noise” on the lower time frames to adequately gauge what is a false break and what is not.

This brings us to the next, very important subject of time frames.

Time Frame Matters

The time frame you use to trade and thus identify these false breakouts is paramount to the overall effectiveness of this strategy.

To explain why this is the case, let’s revisit the EURGBP chart above.

The two instances above were clearly NOT false breaks on the daily chart as well as any time frame above the daily. The pair never actually closed above the critical level; thus we couldn’t consider it a false breakout.

But what about the 4-hour chart?

Let’s take a look.

As you can see, while the daily chart never closed above resistance, the 4-hour chart certainly did.

So was this a false break for those trading the 4-hour chart at the time?

Perhaps, but remember that one of the ingredients for any false break is an obvious level of support or resistance. The retest in the chart above occurred after just one other test of resistance.

With this in mind, attempting to trade or even analyze the price action on a 4-hour closing basis would be ill-advised.

To understand why we have to go back to price action trading 101. One of the tenants of trading between support and resistance is that you must know which time frame is respecting a given level or pattern.

In the case of the EURGBP chart above, the 4-hour had not established itself as the predominant period in relation to the resistance level.

To clarify what I mean by predominant, let’s compare it to the ascending channel that formed on NZDJPY.

Notice how NZDJPY touched both support and resistance on several occasions prior to the false breakout. In this case, the 4-hour chart was clearly respecting the pattern and could therefore be used to assess the implications of the false break that eventually materialized.

Any false break is only as valid (and telling) as the time frame on which it occurs.

So which time frame is “best” for using the technique I’m about to show you?

In my experience, the 4-hour and daily periods work the best. However, each situation is unique, so it all depends on which time frame is respecting the key level in question.

Trading Away From False Breaks

Now that you know how to identify these false moves let’s dive into how you can take advantage of them.

Just like the pin bars we use when trading price action, a breakout that immediately fails is a sign of strength or weakness. We can use this to our advantage just like any other price action signal.

In fact, you can’t have a pin bar on the daily chart without having a false breakout on the intraday charts. The same applies to any combination of time frames.

The NZDJPY 4-hour channel below is a great example. Once the pair closed back below the upper boundary of the structure, it was time to begin watching for selling opportunities.

Note that the pair eventually found a bid right where we’d expect – at the channel support that had attracted buyers on three previous occasions.

In summary, we would have looked to sell on a 4-hour close back below resistance with a target at channel support.

Staying Out of Trouble

Remember how I mentioned that you could have mitigated the risk of getting sucked into these traps at the beginning of this lesson?

The best way to do that is through a firm understanding of price action. And that involves more than just pin bars and inside bars.

Allow me to explain.

You may have noticed that shortly after closing above channel resistance, NZDJPY formed a 4-hour bullish pin bar.

Now, you may be asking yourself, why wouldn’t we have traded that bullish signal, which ultimately failed?

Good question. The reason we didn’t commit to this particular pin bar was quite simple.

The pattern in question is an ascending channel and therefore has bearish implications. As such, we would only want to trade a breakout below channel support, which never materialized before the close above resistance.

Technically speaking, the pattern above was a bearish flag as it was the result of an impulsive move lower. That meant that any buying was counter-trend and thus not advisable.

Pro Tip: As a general rule, ascending patterns have bearish implications while descending patterns have bullish implications.

If on the other hand a pin bar had not formed here and the level was a horizontal pivot rather than a channel, we wouldn’t want to trade the breakout without confirming price action.

What is “confirming price action”, you ask?

Simply put, it’s a bullish or bearish pin bar that forms on a retest of the broken level. It adds conviction to the setup and provides a place to “hide” your stop loss.

You won’t always be able to avoid false breakouts. No technique or strategy will keep you safe 100% of the time.

But through the combined use of technical patterns and bullish or bearish price action, you can give yourself the edge needed to make money over an extended period.

Final Words

The false breakout strategy discussed above is ideal for the more advanced price action trader. If you’re just starting out or not yet profitable using the basic strategies taught on this site, you are probably better off sticking with those to first build a strong technical foundation.

Remember that like any trading strategy, technique or concept, the ideas discussed in this post are based on probabilities, not guarantees. So while a false break of a given level can often result in an extended move in the opposite direction, it does not guarantee the outcome as such.

Whether you use these teachings to formulate an outright trading strategy or only use them to assist in your technical analysis is up to you. As I always say, the “best” trading style is the one that works best for you.

As for me, I simply use the technique above as a way to gauge market strength and therefore add conviction to an already established trade idea.

Your Turn

How do you handle false breakouts while trading the Forex market?

Leave your comment or question below and I’ll be sure to respond.

Leave a Comment:

21 comments

Hi, nice article, thank you. but I see why your analysis fail. your trendline are draw wrong way. this is very common. I am trading FX with trendlines for the passed 8 years.
cheers,
Jim

Jim, the analysis didn’t fail. This was a profitable trade for us due to the strategy mentioned above.

You may be referring to drawing the resistance level a bit higher, which could also be true. But as I pointed out above, the bullish pin bar that formed on the 4-hour chart confirmed that the resistance level was positioned correctly.

Hi Jim,
I don’t see any other way you could have drawn that trendline to avoid the falsebreak prior to it happening. Maybe you should illustrate

hi justin…
I think You should try drawing in a line chart. there will be more opinions…
cheers,
paijo sastro

Paijo, I use a candlestick chart so that wouldn’t work. Also, you wouldn’t be able to identify false breaks with a line chart, at least not in the way that I trade/teach.

Hi, its interesting article, where would I put my stop on a breakout of an ascending triangle? If after an impulse move, would it be better to Sell as it enter the channel and place the stop on highest pivot, the RR would be more reasonable?

Roland, it all depends on the structure. Be sure to visit the lesson on rising and falling wedges, which includes details on stop loss placement. https://dailypriceaction.com/free-forex-trading-lessons/trading-rising-falling-wedge-patterns

This article really clear my doubt on ascending and descending flags now I know the real facts k
Thanks a lot for the articles …hope more will come from you.

Taiwo, glad to hear that. Thanks for stopping by.

Thanks for your article. Does false break only happened in channeling? Could it happen on wedge?

Adi, yes, false breaks can occur on any technical pattern as well as any support or resistance level.

Thank you again Justin, for reminding us to look at the bigger picture, the context of the break, and that trading with the trend has a higher probability of success. so helpful to see the flag or wedge in the context of the bigger trend & to trade a break in the direction of the trend.

Another very helpful article, Justin.

In fact; the whole website, member’s area and support is superb.

The best trading investment I have made was joining DPA.

Cheers for the work you put into it.

Hi Justin,
I thought ascending patterns such as triangles were bullish and descending triangle patterns were bearish. Am I wrong?

HI JUSTIN LOOK MAN AM SO PROUD OF YOU MAN ITS MY FIRST TIME TO TRADE PATTERNS . I AM A NEW TRADER I WAS LOST IN THE MIDDLE OF INDICATORS … LOOK DUDE YOU BROUGHT LIGHT IN MY EYES THANK YOU,THANK YOU THANK A MILLION TIMES YOU THE BEST KEEP UP THE GOOD WORK.

Sometimes false breakouts are due fundamentals

Hello Justin, great article, thank you. In your experience what connotations does a false breakout occurring in the normally expected pattern failure direction carry, if any? I.e an upward wedge having a false breakout downwards for example and then re-entering the structure. Thanks again

What do you do in cases were, there a full body candle closes below resistance. Do you then consider that as a break out. This is when you don’t see any pin bars on that D1chart

Hi there I want to know which of the trading sessions is best for executing trades?

Thanks for the explanation on false break out. where do you think the SL will be placed to trade a false breakout ?

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False Breakout Trading Strategy

False Breakout Patterns

False-breakouts are exactly what they sound like: a breakout that failed to continue beyond a level, resulting in a ‘false’ breakout of that level. False breakout patterns are one of the most important price action trading patterns to learn, because a false-break is often a very strong clue that price might be changing direction or that a trend might be resuming soon. A false-break of a level can be thought of as a ‘deception’ by the market, because it looks like price will breakout but then it quickly reverses, deceiving all those who took the ‘bait’ of the breakout. It’s often the case that amateurs will enter what looks like an ‘obvious’ breakout and then the professional’s will push the market back the other way

As a price action trader, you want to learn how to use false breakouts to your advantage, rather than falling victim to them.

Here are two clear examples of false breakouts above and below key levels. Note that false breakouts can take different forms. Sometimes a false break will occur with a pin bar pattern or a fakey pattern as the false break, and sometime not:

A false breakout is essentially a ‘contrarian’ move in the market that ‘flushes’ out those traders who may have entered on emotion, rather than logic and forward thinking.

Generally speaking, a false-break is happens because amateur traders or those with ‘weak hands’ in the market will tend to enter the market only when it ‘feels safe’ to do so. This means, they tend to enter when a market is already quite extended in one direction (and it’s about ready to retrace) or they try to ‘predict’ a breakout from a key support or resistance level too early. Professional traders watch for these missteps by the amateurs, and the end result is a very good entry for them with a tight stop loss and huge risk reward potential.

It takes discipline and a bit of ‘gut feel’ to know when a false-break is likely to occur, and you can never really know ‘for sure’ until after one has formed. The important thing, is to know what they look like and how to trade them, which we will discuss next…

How to trade false breakout patterns

False breaks occur in all market conditions; trending, consolidating, counter-trend, but perhaps the best way to trade them is in-line with a dominant daily chart trend, like we see in the chart below.

Note, in the chart below, we had a clear downtrend in place and multiple false breakouts to the upside within that trend. When you see a false breakout that is against a dominant trend like this, it’s usually a very good signal that the trend is ready to resume. Amateur traders love to try and pick the bottom in a downtrend or the top in an uptrend, and this can cause false breakouts against the trend like we see below. On each of these false-breaks in the chart below, it was likely that amateur traders thought the downtrend was over and so they started buying, once this buying started the professionals came back in and took advantage of the temporary strength within the down-trending market and entered short from value, and then the downtrend resumed, flushing out all those amateur traders who tried picking the bottom.

The chart below shows examples of false breakouts within a down-trending market. Note that each one led to a resumption of the trend…

False-breaks are prevalent in trading ranges because traders often try to pick the breakout of the range but usually price stays range-bound for longer than most assume. Knowing that false-breaks are somewhat common when a market is struck in a trading range is a very valuable piece of information for a price action trader.

Trading a range-bound market can be very lucrative as you can wait for price action signals at the support or resistance boundary of the range to trade back toward the other side of the range.

The best way to be sure you don’t get caught in a false-breakout from a trading range is to simply wait for price to close outside of the range for two days or more. If this happens, there’s a good chance the range is finished and price is then going to start trending again.

In the chart below, we can see how a price action trader can use a false breakout pin bar signal to trade a false breakout of a trading range. Note the false break pin bar at the trading range key resistance, and also note the two false-breaks at the trading range’s support. More experienced traders can also trade false breakouts that don’t contain a price action trigger like a pin bar. The two false-breaks of support in the chart below were both potential buy signals for a savvy price action trader…

False breakout patterns can sometimes signal the beginning of a new trend, and the end of the current one.

In the chart example below, we can see a key resistance level that held price on two tests, then on the third test, price created a large false-break pin bar strategy that signaled a potential down move was coming.

As we can see in this chart, not only did the false breakout signal a down move, but it kicked off an entire downtrend…

False Breakout Pattern Trading Tips

  • False breakouts occur in trending markets, range-bound markets and against the trend. Watch for them in all market conditions as they often give strong clues as to impending market direction.
  • Trading counter-trend is difficult, but one of the ‘best’ ways to trade against a trend is to wait for a clear false breakout signal against a trend from a key support or resistance levels, as shown in the last example above.
  • False-breakouts give us a ‘window’ into the ‘battle’ between amateur and professional traders, hence, they give us a way to trade with the professionals. Learn to identify and trade false breakout patterns and trading will take on a different light for you.

I hope you’ve enjoyed this false breakout pattern tutorial. For more information on false breakout patterns and price action trading click here

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