So, this is a true story…
When I first got started in trading, I was new to it right?
I just learned about price action trading and I would look at a chart, a naked price chart.
And I see the market breaks out.
Strong bullish momentum.
I can imagine the candles, they're so large and I think to myself…
"Man, the breakout is real, it's time to go along, it's time to buy because I don't want to miss any more of the move, so I buy!"
And then what happens is that, shortly afterwards, the market reverses and I cut my trade and I suffered a loss.
I was stubborn!
I was an idiot!
I kept doing this a lot of times!
I lost track the number of times I did this...
Every time the market stages a strong rally, the stronger the momentum, the larger the candles, you can be sure I would buy that kind of breakout.
And I lost money consistently...
It's only after I've been in the trenches for years, I realized that "Hey, chasing this type of breakouts is a losing money proposition."
Now, the question is how do you actually avoid false breakout?
That's what today's video is all about!
How do you avoid false breakout?
The first thing to let you know is that there is no way you can avoid false breakouts completely.
There are certain times, a certain percentage that no matter how good the setup is…
You are still going to get caught on a false breakout, but you can minimize the chances of you getting caught in a false breakout.
The first tip that I have for you is…
Stop chasing parabolic moves
What are parabolic moves?
Parabolic moves, they are in essence what I've just described earlier.
The price moves up with little to no pullback and then it goes up higher:
If you see a big ballistic strong momentum move like this...
Don’t chase this type of breakout, because more often than not, the market will reverse:
Why is that?
Let me give you a simple explanation why this usually occurs…
When you chase a market where it's making a strong move or a parabolic move, there is no floor to support these higher prices.
If you compare to markets that exhibit this type of price action that goes up and retraces…
This type of price action has levels like swing lows to support these higher prices:
If the market were to reverse, it would find a floor or support, where potentially buying pressure could push the price higher.
These types of moves are more sustainable, because they are a series of higher floors along the way to support higher prices.
Unlike this type of strong parabolic move:
It goes straight to the moon, those are the type of breakout trades that are likely to fail.
Let me share with you a few examples...
The first one that I want to share with you is a chart from NATGAS GAS FUTURES (NG1!):
If you look at this chart of natural gas…
Do you want to be buying at this point and time?
Well, you might be thinking, “Oh Rayner! right now you can be sure I would buy this market right now. After all, it's bullish! it's parabolic! look at the strength of the momentum!”
I need to slap myself and wake up because no…
I will not do it anymore…
Because in my experience based on my own trading account, I know that this in the long run, it is a losing proposition.
What happens is that the market has gone parabolic.
If you want to buy now, it's too late.
In fact, you want to stay away, stay on the sidelines.
Because there's a good chance that if the reversal comes, it can be very swift towards the downside back to this nearest support or floor area where buyers could come in:
And the nearest area would possibly be somewhere here where previous resistance could act as support:
It's going to be a huge distance, where the reversal can only reverse quite a long way down:
Number two, if you were to buy a breakout at this point in time.
Where is a logical level to put a stop loss
If you ask me…
The nearest market structure or support is somewhere here:
Your stop loss, in essence, would have to be this wide:
From a risk to reward perspective, it doesn't make sense.
Because for you to earn your initial risk, the market has to move this much in your favor for you to earn 1R
Which is basically multiplied by one from your initial risk.
If you risk $500 on this wide distance as your stop loss, the market has to move this much just for you to make $500:
A wide stop loss, in essence, gives you a very unfavorable risk to reward.
This is one example of natural gas.
Stop chasing markets like this, because you will eventually thank yourself that you don't make these poor breakout choices in future!
Another example that I want to share is the chart of NZD/JPY:
If you look at this, the magnitude is not as large but the concept is the same…
You don't want to be chasing breakouts after the market has made a strong momentum move.
For example, this one over here:
A strong momentum move towards the upside and breaks out.
If you see such breakouts, tell yourself, "I'm not going to chase it.”
The market did eventually reversed down lower:
Again, look at the very strong momentum move towards the downside.
You don't want to be chasing these types of breakouts.
Again, as I mentioned, because if it reverses, it can reverse quickly towards the upside against your position!
And to set a stop loss on such a trade, it's going to be very wide.
Because your stop loss has to go above this market structure at this high which results in a very poor risk to reward on your trade:
If you just implement this one tip, I can assure you your breakout trades will be much more profitable going forward.
The last example that I want to share is BTC/USD:
Bitcoin, if you recall the mania up to 20,000, again, if you look at the chart, it is very similar to natural gas.
If you see this type of price action with big, bullish candles…
Stop chasing the market, it's too late to enter…
And true enough, in this case, the market went up a little bit higher.
You might see a few profits on your trade before it collapses all the way down to like $6,500 at this point of doing this video:
This is the first tip that I have for you, don't chase breakouts.
Now some of you might be wondering, "Hey Rayner, okay, I won't chase breakouts. So, how do I trade breakouts?"
I got one tip for you…
Trade breakouts with a buildup
What is a build up?
A build-up means the market is in consolidation and it can be identified in three ways: