3 Tips for Trading Breakouts
With the holiday coming tomorrow, I wanted to write a short price action article with 3 quick, but highly useful tips for trading breakouts. If you can add these to your price action toolbox when trading breakouts, you can increase your success rate significantly when trading them.
1) Time of the Day
One of the key components to a successful breakout is volatility. When you have greater volatility, you have more orders/players behind the market and therefore increase the probability the breakout bar will have more force behind it. This helps the breakout bar to take out more stops and push the market further in the breakout direction.
But, volatility fluctuates tremendously throughout the day. Statistical analysis has pointed out to how breakout strategies actually function far better during the London and NY session while tend to fail during Asian market hours. This is simply to do with volatility, so the time of the day you take the breakout trade will have an impact on the success of your trade.
Ideally, breakout trades are taken during the following times;
-1st three hours of London session
-30mins before NY open up to 30mins before London close
A great example of this is in the chart below how price consolidated for a day and a half, then broke out massively during the 2nd hour of the London session.
Outside of these times, the probabilities decrease for your breakout trade (variably depending upon hour) as volatility is either low or in a declining phase and may not have the order flow behind it to break through the key levels. Also avoid taking breakout trades several hours prior to major economic announcements, or going into major holidays where trading and liquidity will be subdued.
2) Use Options Data to Aid Your Timing
Daily FX has a useful piece of data in their technical analysis page whereby they publish a Volatility Percentile feature. This is derived from options prices with a higher number communicating options traders are expecting greater volatility, while a lower figure suggests more range bound/reversion to the mean type play.
You can simply check the data at any time (per pair) to see where the volatility percentile figure is at. When you are thinking of taking a breakout trade, ideal is to have the Volatility Percentile figure above 70% or greater, suggesting options traders are expecting a greater amount of volatility in the market and thus increasing the probability of your breakout trade working out. If several of the pairs are above these percentages, then there is broad market participation which will likely create strong impulsive moves in the market which are ideal for breakout trading.
3) The Longer the Compression, the Better
Usually breakouts give you several warning signals ahead of time a breakout is happening, either via a squeeze in the price action to one side of the market, a tightly coiled range or higher low/lower high forming inside the range. Regardless of what the clues are, the longer the compression in the price action, the better.
Markets, traders (and brokers) do not like tightly bound up price action. Smaller ranges and markets mean less continuation and directional follow through. If markets turn around quickly, they offer us less profit in the direction we have chose. But a long compression in the price action will build up a pressure and friction which eventually needs to be released. The longer this builds, the better, for when it breaks out, the market can often go for a large move in the breakout direction as seen in the chart below.
You will notice in the chart above how the price action was consolidated in a tight 200pip range for almost two months. But when it broke out, forming the breakout bar, it sold off for the next 5 days in a row, 11 out of 12 days and 13 of 15 days, selling off for over 700pips.
Breakout trades can offer some really profitable opportunities, but can be maximized by adding these three tips above which are;
1) Time of the Day
2) Using Options Volatility Data
3) Looking for long compression periods prior to the breakout
If you can learn how to spot these, along with other various price action clues, you can increase the profitability and success rate to your breakout trading.
For more info on how to trade price action and breakouts, along with lifetime membership, getting access to the traders forum & a lot more, make sure to visit my price action course page here.