This week’s question comes from Pierre, who asks:
Are there cases in which you can enter a breakout trade that didn’t fully retest without chasing?
That’s a loaded question but no doubt a good one. To clarify, what Pierre is asking here is what to do when a market breaks out but doesn’t retest the broken level as new support or resistance.
The more challenging part of this question are the last two words “without chasing.”
There are a couple of things you can do in this case. Of course, the most obvious is to simply do nothing and move on to the next trade idea.
Despite sounding like a rather dull and unprofitable solution, doing nothing is often the best course of action. After all, one way to increase profits in any business is to cut costs, which is how I view trading losses.
But there is a way to take advantage of a breakout that doesn’t retest without chasing. It’s something I do quite often when a market doesn’t pull back far enough to justify an entry yet is too extended to justify an entry.
In this post, we’ll discuss how to go about finding second chance opportunities that can still yield excellent results.
Know Your Levels
Before you even consider buying or selling a currency pair, it’s imperative to identify key support and resistance levels.
By doing this, you can establish a game plan for future price movement. In other words, all you need to do once you have these levels on your chart is sit back and watch for buying or selling opportunities.
This practice of marking support and resistance first not only helps remove emotions from trading but it also allows you to identify second and even third chance opportunities.
Take the AUDUSD daily chart below as an example. As you can see, an upward sloping flag had formed after an extended move up.
Notice that the pair never actually retested former channel support as new resistance after the breakout was confirmed.
If you were somehow able to secure a favorable entry on an intraday chart, that’s great. It certainly played out well for those who did.
But what if you didn’t?
Maybe you weren’t around when it happened, or perhaps the pair fell short of triggering your limit order. We’ve all experienced that feeling of opening up our platform to find that the market missed a pending order by five pips.
In these cases, you can look for second chance opportunities such as the bearish pin bar above. As the name implies, it’s an opportunity that develops after the initial breakout.
But to do this in a profitable and controlled manner requires two things. One is a physical act while the other is an acquired attribute.
1. Predetermine support and resistance levels
When you open a new chart, the very first thing you should do is identify key support and resistance levels. Those lines will serve as an outline so to speak from which you can watch for buy and sell signals.
I was asked just the other day if it’s acceptable to draw a level because a pin bar formed.
The concern I have with this approach is that it puts the effect in front of the cause rather than the other way around. We know that a pin bar forms as a result of increased supply or demand around a particular price.
The candlestick pattern helps to confirm the validity of an area of support or resistance. That long upper or lower wick of the candle is what signals the influx of bids (buy orders) or offers (sell orders).
So if you wait until after a pin bar forms to draw a level, you aren’t actually confirming the level. Instead, you’re using the candlestick to identify an area that may or may not be relevant to the surrounding price action.
That can get you in trouble if you aren’t careful. There’s a fine line between seeing what the market is doing versus seeing what you want to see.
Said differently, your mind will often play tricks on you when money is involved. For this reason, it’s always best to draw levels first and then watch for opportunities from those areas.
By drawing support and resistance first, you reduce the odds of seeing something that may not be worth your time and money.
Without patience, you won’t have what it takes to wait for a favorable second chance opportunity to materialize.
Now, I realize that saying things like patience is key to your success is easier said than done. And while I would love to tell you there’s an easy way to inherit a high degree of patience as a trader, there are no shortcuts here.
Patience is developed, not given or taken. It takes most traders years to develop the kind of patience necessary to succeed, not days, weeks or even months.
However, the fact that it’s something you develop over time is also good news. It means you don’t have to wait days weeks or months to see improvements in your trading.
The best way to achieve a high degree of patience is to just keep at it. Continue studying the markets, taking notes, asking questions and never be afraid to make a mistake.
But above all, never give up.
Never Chase a Runaway Market
Chasing a breakout doesn’t usually end well from my experience. It doesn’t allow for a favorable risk to reward ratio which should be a top priority for every trader.
Furthermore, it puts you in a situation of buying high or selling low rather than waiting for the pullback.
I often talk about mean reversion and its importance when timing an entry. The problem with chasing a runaway market is that it contradicts the idea of allowing a reversion to occur before considering a position.
For these reasons, I would always rather miss a breakout than chase a market that doesn’t pullback.
It doesn’t matter how favorable the risk to reward might be; it’s never worth chasing a runaway market. Doing so could not only cost you precious capital, but it also fosters bad habits and encourages a lack of patience.
Knowing where support and resistance levels are for each currency pair is the best way to identify second chance opportunities. Once you have these levels marked, the only thing left to do is watch for buying or selling opportunities.
Patience is developed over time. It takes months and years to develop the degree of patience necessary to succeed, but it’s a necessary attribute to spot favorable second chance opportunities.
If faced with the decision of chasing a breakout or missing a trade, you’re probably better off staying on the sideline.
Even a profitable trade made for the wrong reasons is a bad trade. Remember that what you do every day becomes habitual, so be sure to do what you know to be right even if it means missing a breakout.
There will always be another opportunity tomorrow, so don’t worry about missing one today.
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
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