This week’s question comes from Margaret, who asks:
How do you define a breakout in the Forex market?
I would bet that most Forex traders can identify a breakout.
As the name implies, it’s when a market breaks out from a key support, resistance level or technical pattern.
Sounds simple enough, right?
But what if I told you that most traders get it wrong? In fact, my description above is incomplete without mentioning one key factor.
In today’s post, I will discuss and illustrate how I define a valid breakout, including the type of chart I use, and why it’s so important.
I’ll also get into whether or not you should wait for a retest following the breakout. While the answer is subjective, there are two critical factors that can help you decide which path to choose.
Without further ado, let’s begin!
What Does It Mean to 'Break Out'?
If you’re an experienced trader, you can probably move to the next section. However, if you’re in any way unsure of what it means for a market to break out, you will want to read the next few paragraphs.
A breakout simply refers to the point when a market breaks beyond a key support or resistance level. It can be part of a technical pattern such as a channel, a horizontal level or even a trend line.
As price action traders, these breakouts are a critical component. They help us determine where the market is likely to go next.
Most breakouts occur after a period of consolidation. Once the market is ready to continue trending, price breaks through a key barrier, representing an opportunity to buy or sell.
Beware of Intraday Noise
The Forex market is full of noise. Everything from a rate decision and statement to non-farm payroll can cause disruptions.
However, these events also move the market, so they aren’t all bad. If it weren’t for market moving announcements, you and I would be pretty bored and perhaps out of a career.
You may be wondering, what is “intraday” noise?
The term intraday means within one day. When discussing events like the ones above, it refers to the volatility caused by an event within the 24-hour period that begins at 5 pm EST.
As you may well know, I use New York close charts. That means that each 24-hour session opens and closes at 5 pm EST.
The advantage is that I have five 24-hour periods each week. That may seem trivial, but I can tell you from experience that if you’re trading from anything but New York close charts and utilizing price action signals, you’re going to run into false positives.
In other words, your chart may show a buy or sell signal, but the rest of the market, including the professionals, don’t see it that way.
Want access to the same New York close charts I use? Click here
So what does this have to do with breakouts in the Forex market?
In a word, everything. That close at 5 pm EST is the breakout. If the market can’t clear a support or resistance level at the close, it is not a confirmed breakout.
Here’s an example on the EURJPY daily time frame:
Notice how the market moved above key resistance intraday, but wasn’t able to close the session at 5 pm EST above resistance.
Therefore, the price action above does not represent a confirmed breakout. Yet I guarantee there were plenty of buy stop orders just above resistance during this time. Those positions never stood a chance because of the head fake in the chart above.
Now, here’s what happened just a couple of weeks later:
After a few intraday spikes above the level, the EURJPY managed to close the day above resistance. Once this occurred, you could begin watching for a buying opportunity on a retest of the level as new support.
What followed was a 300 pip rally.
If you take nothing else away from today’s lesson, let it be this…
When it comes to breakouts, the daily close at 5 pm EST is all that matters. Everything else that occurs intraday is just noise and is therefore insignificant.
Should You Wait for a Retest?
Now that you know to use New York close charts and how to avoid the intraday noise, let’s discuss retests for a moment.
One of the most common questions I receive is, should I wait for a retest of a broken level before entering?
To be honest, there is not only one correct answer. Every trader has to determine what works best for him or her.
That said, there are a couple of considerations when deciding which approach you should take.
1. Where is the Mean?
The concept of mean reversion in trading refers to the assumption that a market will return to its average price over time. This is one factor I have seen many traders neglect.
Take the chart below as an example.
In this case, I’m using the 10 and 20 exponential moving averages (EMAs) to identify the daily mean, or average price.
During an uptrend, the AUDUSD moves considerably higher in a short period, creating space between the price and the 10 and 20 EMAs.
I call this space an overextension. So if you ever see me write that a market is overextended, I’m referring to the vast distance between the current price and the EMAs.
The same concept applies during a downtrend. The market makes sharp moves downward, but eventually reverts back to the mean as represented by the 10 and 20 EMAs.
When deciding whether or not to wait for a retest, you should always ask yourself, where is the mean?
If it’s relatively close to the current price, you may be able to enter without waiting. However, if the market is overextended, chances are you’ll get a retest of some sort before the next leg materializes.
2. Is a Favorable Risk to Reward Possible?
After you’ve identified the distance between the current price and the mean, the next thing you want to determine is the risk to reward ratio.
I personally use a three-to-one reward to risk ratio as a minimum for any setup.
What does that mean, exactly?
It means that the potential reward of a setup must be at least three times the risk. Otherwise, I’ll dismiss the setup and look elsewhere.
So, if the stop loss is 100 pips from the entry, the reward must be at least 300 pips away. You can also use a two-to-one ratio, but I wouldn’t go any lower than that.
Spotting a breakout in the Forex market seems easy enough. You wait for the market to move above or below a key level, and then look to trade in the direction of that move.
However, a true breakout is much more than that. It requires patience to wait for the daily session to close at 5 pm EST. Otherwise, you run the risk of entering too soon and getting caught on the wrong side of the market.
The fastest way to improve your trading is to start waiting for each 24-hour session to close before further deliberation. That means waiting for the New York close at 5 pm EST. It removes a lot of the intraday “noise” and slows your trading down, which is a good thing.
Your Turn: Ask Justin Anything
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
- Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
- Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.
I tried to apply ur swing lesson for GOLD…
I manage to gain some profit but the progress seems very slow…
Anyway that I can improve my trade for GOLD
I am not sure how to show you my trade screen shot, I just post it on my whatapps
Sorry, I don’t know the details of your trade, but you can’t judge the effectiveness of a trading style from one setup.
Thank you Justin, what is the price to be in your membership area?
2.do you trade Xauusd? Why does this pair always look like the opposite of usdjpy and it’s like it depend much on the usd to go the opposites? What’s your oppinion
I’ve seen you using horizontal levels, and you use trend lines of different years. Which one is more powerful. If both, then how to use both of them?
Well educative, I’ll still go over it.
Thanks Justin, as always very informative and kept simple.
My question borders on how to handle my trade in a very long trend where the price price gets overextended several times and reverts to the mean severally before getting to the target. Do I keep closing and reopening the trade each time or just keep watching gains already seen keep disappearing and reappearing with the attendant risk of a possible massive pullback which is a possibility
I really wish for an answer to your Q Emeh.
I am trying extremely hard to trade the daily candles….but cannot atest to ripping the rewards just yet…..however I am a newbie to trading the D1 candles….What is your candid advise to a frustrated newbiee like me!!😯😯😯
Thanks Justin quite nice and clear as always!
How many of your trading setups, on average, get matreialzed each month?
Since I come across your site it has really been helping me mostly the mean reversion. Thank you hope to be member very soon
As always very informative. Thanks for the article
My question is when the price moves from the extension to the mean how will I know whether it’s an uptrend or downtrend when the 10ema is about to cross the 20ema but does not cross. Initially the 10ema is below the 20ema but bending to show a cross but doesn’t cross and the price is already in the mean reversion
Enter your comment…how you know if to buy or sell in forex, and what is the right time to enter the market
Thanks Justin, it was helpful
This is very helpful and very useful, thank you Justin.
Anyway my question is not quite related to the content above…how do you monitor your trade setups?
Thanks for the information ,i find it very helpful in my trading
The fastest way to improve your trading is to start waiting for each 24-hour session to close before further deliberation.This is where am having a big Challenge but with this article i’ll improve. Thanks a million times Mr Justin Bennett……
hi justin.Please explain the following questions
1-Why do you draw key of a line as a line.Why do not you design them as a range؟
2-Do not have to pay attention to the main moves before entering the currency؟
3-we do not need a pin bar or angulphin after the breakout?
4-Is breakout a type of entry setup in price action?
Justin, your analysis is spot on, Your seven dollar course should be bought, to save a trader two years of wasted time . Thank You again for your time.
thank you so much sir, I have cleared many confusions. God bless you!
Useful as always Justin.
I am just starting to read the modules in the course so i reserve my questions after…thanks for these as i am learning a lot from you @JustinBennettFX
Do time frame affect this chart pattern.
Thank you Mr Justinn, I really would like to see your analysis on XAUUSD,XAGUSD,CRUDE OIL,COFFEE and XRPUSD
hi justin its very clear …could you please give me example in chart for your words ……” If it’s relatively close to the current price, you may be able to enter without waiting” ….thanks
How you identify the stop loss and profit taken level?
Justin enough said no words could explain better than what uv just said nw it’s a strategy on its own combining all at once, thanks for sharing such powerful information God bless
thank you for your always exciting and brilliant insight into Forex techniques.
I take you as a guru and a mentor to follow.
I have an interesting question, I was recently in a Forex competition that had a tenor of 8 days( the competition was to last for 8 days only after which the winner was to be decided), we were all given a demo account with USD100,000 and 1:500 leverage, within 7 days most of the contestants had grown their balances by 700% (that is from 100,000 to 700,000 in 7 days), please do you know of any strategy(s) that they may have used to grow their balances at such a short period of time, what strategy can you advice that one use to ensure a fast and consistent growth of equity ( account) balance?
Thank you for your prompt and brilliant answer. Eugene.
Is it possible to grow an account 700% in 7days? Amazing, never heard of that before.
It’s possible but over the long term you will lose that percentage gain. Better to make on average 2% a month in my opinion
Spot on, Roy!
Excessive leverage, lack of risk control, recklessness; but those aren’t strategies.
Anyone who makes that sort of return is sure to lose it just as fast. If you want to make it in this business, focus on slow, steady growth.
This practice is very often in competitive accounts, where the goal is to make the maximum profit in the shortest possible time. In order to win, intraday trading is used and a very large leverage is used. Due to this, each transaction brings a very large profit. But like any medal, there is a downside to the coin, if the deal is open in the wrong direction. Losses can be just as high.
As has been said in the long run, this chase can lead to sad consequences.
The size of the transaction, the number and frequency of transactions should depend on the professionalism of the trader and his confidence in the success of the forthcoming deal, as well as the degree of internal comfort.
Thank you. This was insight full with clarification on whether enter after retest or after breaout.
I have a question, Lets say a currency breaks out and you got the entry, exits and risk reward ration correctly. Target profit being the next support/resistant hypothetically about 120 pips away.
The trade goes all well, hits the set target, but the momentum is too strong that it continues to rally in the direction you had predicted breaking the support/resistant at your target over in an overextended position. And it continues to rally maybe 400 pips down like that.
How do you capture such a trade so that you get the most out of it
I’m learning to a good trend follower. I’ve very well how to identify trend and place trades with the trend. But I really need to know when the trend is about to turn or end so I can get out.
Do you know when a trend is ending or about to turn?
Problm drawing those MAs plus the time zones. shld we match our different times zones with Australia where Blueberry is based or New York since we use NY Close Charts. How do we calculate to identfy our local closing time using tht 5pm EST. HEEEEEELP
Blueberry Markets offers New York close charts, so if you’ve signed up, there’s nothing more you need to do.
I’d reach out to them if you have any more questions about their charts.
This is so informative….Thanks Justin, I will add this to my price action trading tools
What is the easiest way to sport the difference between a retracement and a reversal?
Tks Justin. Always simple and very informative. Keep on the good work!
Does it mean that one should not trade the daily London break out on H1 chart ?
I have been away for some time, but many thanks for this. However, in your opinion, how many pips is enough to determine when price has over extended
Very well explained Justin
Thanks for the insight
Thanks Justin, very informative and helpful fora beginner trader like me.
I am impressed with your lecture. i will put it into use and send you a feedback. You are an excellent educationist. Thank you sir i am grateful
I’m Lucky and always believe Justin Bennett is my best teacher for Forex .Thanks a lot…
Much Thanks to you Sir
Hey Justin. I want to thank you so much for your lessons. I have been selling for a long time already, and your advice and reviews are very helpful to me. It’s quite difficult for me to switch to day trading, because I always trade within a day, but still you give guidance where to expect traffic. Because I also have a lot of experience, then I do not always agree with your opinion, but at the moment your forecasts are more correct. And thank you for that. I rarely see those whose forecasts are so good.
I wish you luck and happiness.
What do you think aboutWhat do you think about currency pairs aud/usd, aud/jpy?
aud/usd because of the dollar is constantly in the flat and apparently will start moving up immediately with a change in the dollar’s trend.
aud/jpy now is near the point of resistance and if in the coming days does not fall down on the daily schedule, we can expect further upward movement up to 87.65 per week. Naturally with possible kickbacks. What do you think about this situation?
gbp/usd – is really pegged to the dollar that now hinders its movement upwards, however gbp/jpy For a long time, it shows a good upward movement and, according to the daily schedule, one can expect further movement. Do you agree with me?
While using g 10 & 20 EMA s on the settings do you apply to high or close.
thanks you so much sir, please guide us what we should do with our trading in speeches day and how many points of stop loss from the entry.?
so basically,you will consider a good breakout only in the daily chart? i said this because i thought that a breakout in the 4h timeframe was good too
I’ve read a lot about stock traders who trade “momentum bursts” lasting three to five days.
Are these momentum bursts simply another term for breakouts?
These traders seem to simply be swing trading breakouts. Nothing new there. I have to assume that momenrum bursts are simply breakouts which occur in all markets.
thanks very helpfull content
i really needed this
In this article you give very useful information about breakout trading.Breakout trading is a technique to enter the market while the price shifts outside the defined costs range. Although, an efficient breakout always comes with raised volume