Breakout trading candle is one of the most used strategies by traders to find profitable trades in the market. At its core, breakout trading is when a price breaks through a level, support or resistance. This move means momentum is about to pick up, either up or down and we can get in the trade in the direction of the breakout.
One way to find these breakouts is by using candlestick patterns. These patterns show price action over a certain period and can tell us if the breakout is real or just fake. In this article, we will go deeper into what breakout candles are, how to identify them and key strategies to use the breakout trading.
What is a Breakout Trading Candle?
A breakout trading candle is a special candle that signals a big move in a particular direction. It breaks through a key level of support or resistance and shows a clear change in market sentiment, either bullish or bearish depending on the direction of the breakout.
There are two primary types of breakout candles:
- Bullish Breakout Candle: This candle indicates a price breakout to the upside. It typically has a long body, which shows strong upward momentum, and little to no wick on top, suggesting there is still buying pressure.
- Bearish Breakout Candle: This candle points to a downward breakout, usually featuring a long body moving downwards, signalling strong selling pressure.
When you see a breakout candle, pay attention to a few things. First, the size of the candle matters. Bigger candles have stronger breakouts, smaller candles are indecision in the market. Second, volume is key. The high volume on the breakout candle is confirmation the breakout is real.
Key Indicators for Successful Breakouts
Identifying a breakout candle is just the first step. For a successful breakout trading strategy, you need to look for additional indicators to confirm the strength and reliability of the breakout.
- Volume Confirmation: When a breakout occurs, rising volume is a key sign that the movement is backed by strong participation. If the breakout happens on low volume, it might be a false breakout that could reverse shortly afterwards. Thus, always make sure the breakout candle is supported by increased volume.
- Support and Resistance Levels: Breakouts typically occur at important support or resistance levels. A breakout above resistance indicates that buyers are in control, while a breakout below support suggests sellers are dominating the market.
- Candlestick Patterns: Certain candlestick patterns are excellent at predicting breakouts. Patterns like engulfing candles, hammers, and shooting stars often signal a potential breakout. For example, an engulfing candle shows a complete reversal of the previous trend, and when it breaks through a key level, it’s a powerful signal for traders.
- False Breakouts: Not every breakout leads to a sustained price movement. False breakouts occur when the price breaks through a key level but quickly reverses direction. To avoid getting trapped by false breakouts, traders should wait for confirmation such as a close above or below the breakout level and strong volume support.
Types of Breakout Strategies Using Candles
Different market conditions call for different types of breakout trading candle strategies. Here are some common ones:
- Trend Breakouts: These occur when the price is already in an established trend, either upward or downward, and breaks through a key level, indicating the continuation of that trend. A trend breakout is usually accompanied by large breakout candles and high volume, signaling strong momentum.
- Range Breakouts: When the market is moving sideways within a defined range, breakouts occur when the price moves beyond the upper or lower boundary of the range. These breakouts often lead to a strong directional movement once the range is broken.
- Continuation vs. Reversal Breakouts: In continuation breakouts, the price breaks in the same direction as the trend, whereas in reversal breakouts, the price breaks against the trend, signaling a potential reversal. Understanding these distinctions helps traders decide whether to follow the trend or anticipate a reversal.
Risk Management in Breakout Trading
Trading breakouts can be rewarding, but it also comes with risks, especially when the breakout fails. Effective risk management is crucial for success:
- Stop-Loss Placement: Setting a stop-loss order is essential in breakout trading. It helps you limit losses in case the breakout turns into a false one. Ideally, you should place your stop-loss just below the breakout level (in case of a bullish breakout) or above it (in case of a bearish breakout).
- Risk/Reward Ratio: Aim for a risk/reward ratio that ensures that your potential profit outweighs the risk. A common rule of thumb is a 1:2 or 1:3 ratio, meaning you aim to make at least twice or three times what you’re risking.
- Managing Volatility: Volatility often spikes during breakouts, which can cause sharp price swings. Make sure you’re not over-leveraging your positions to protect yourself from large losses due to sudden volatility.
Real-Life Examples of Breakout Candles
Real life examples can give us a better understanding of how breakout trading candle work in action. For example, look at this recent forex chart where a currency pair broke above a strong resistance. The breakout candle was a long green candle and the volume exploded, confirming the breakout. Traders who traded on this signal made a nice trend trade.
In another example, a stock showed a breakout below a key support level with a bearish breakout candle, followed by a sustained downtrend. This was a clear bearish breakout that rewarded those who were shorting the asset.
Common Mistakes in Breakout Trading
Even experienced traders can make mistakes when trading breakouts. Here are a few common ones:
- Chasing Breakouts Too Late: Entering a trade after the breakout has already happened can lead to poor results. It’s crucial to act early and avoid chasing after the price has already moved significantly.
- Failing to Recognize False Breakouts: Not every breakout leads to a sustained trend. Be cautious of false breakouts and always look for confirmation.
- Not Using Proper Risk Management: Trading without a stop-loss or proper risk/reward ratio can lead to substantial losses.
Conclusion
Breakout trading candle can be an effective strategy for spotting and capitalizing on market momentum. By understanding what breakout candles are, identifying key indicators, and applying the right strategies, traders can improve their chances of success. However, risk management and avoiding common mistakes are equally important to ensure you don’t fall victim to false breakouts or excessive volatility. Remember, practice and patience are key to mastering the breakout trading strategy.