Price acts like a coiled spring.
When it is wound into a range and then “let go”, the price expands quickly, presenting traders with some of the best risk/reward trading opportunities.
Of course, the typical response from the retail trader is to fight the flow.
But why not accept what is plainly visible in front of you, and go with it instead?
The range must be “persistent”
You are looking for times when the markets move sideways for a long period of time, hence you will want to use weekly charts to look for ranges. The markets should be persisting in a range, and the range should not be wide and volatile.
Rule #1: Identify persistent sideways quiet and sideways normal MT’s on the weekly charts.
Note these market types are quite rare. This is not a strategy for impatient traders.
Know the fundamental catalyst
If there is a fundamental reason for the breakout, then the trade will be a superior one. You are not looking at minor news items here; the bigger the better.
For example, Donald Trump’s surprise win of the U.S. presidential election in 2016 is a major catalyst, while a PMI manufacturing figure is not.
There does not always need to be a catalyst when you trade these breakouts (sometimes you’ve got to trade the price first—a lesson learned from macro giant, George Soros). But if there is a catalyst that is clearly recognizable, it should increase your confidence in the trade.
An important psychological caveat of trading success is that you like the trade, as otherwise it’s hard to trade it at a meaningful size.
Rule #2: Make sure you like the trade; a clear fundamental catalyst will help (for more on this, see lesson #19 of the Advanced Forex Course for Smart Traders)
Hunt a superior risk/reward ratio
When you see a persistent sideways market type, then it’s time to go-a-hunting.
Like a cheetah stalking its prey, lie in wait for the best time to enter, the time that presents the optimal risk/reward profile.
Mark the breakout point (I use the weekly Bollinger Bands) on your chart. Then go down to the daily timeframe and wait for a close over the point you have marked. This is your entry trigger.
Rule #3: Wait for a daily close over the breakout level to enter.
You may also want to consider using stop entry orders to enter the position. If this is the case, then make sure the orders are placed 0.3% on the far side of the Bollinger Band or key level that you anticipating the break-out from.
Alternative rule #3: Place a stop entry order 0.3% on the far side of the break-out level.
Prudence first when breakouts fail
Of course, the market tends to do what it wants irrespective of your views, so protecting yourself is mandatory. Make sure you have a stop-loss in place.
Rule #5: Place a stop loss 0.5% behind the entry week. You can use some discretion here if the week is very large. Head to a lower timeframe to look for the appropriate place to put your stop.
This is where you go for the big wins
These trades are not for wimpy traders. Breakouts provide the opportunity to garner a few massive winners. Hence the complex exit strategy for breakouts focuses on maximization, rather than consistency.
But you need to be prepared to hold on through the swings that occur. The price won’t go in a straight line to your target, so don’t sweat about every little pull-back. Place the trade and hold on for dear life.
For these purposes, we use the super-trend indicator on wide settings.
Rule #6: Place a trailing stop on the Super trend indicator (3,7).
We also want to make sure we don’t give back too much when we get a good trend, as it will make sitting though the big swings that much easier if we have some locked in.
Rule #7: Close 1/3 of the position if the Super trend indicator (1,7) changes direction. If the trend then continues, close 1/3 more the next time the indicator changes direction.
Watch for the exit signals
The market generally tells you when the trend is done. Look for these two things:
- The market to go parabolic with big long candles outside the Bollinger Bands.
- A double bottom or top to form.
In these cases, you want to protect your profits and exit.
Rule #8: If the market type turns extreme, then trail the stop by 3% on 1/3 of your position.
Rule #9: Exit on a major double bottom or top.
Windfall gain targets
Just in case the price does something crazy and goes for you, keep a target in place on a major level. This should be at least 20%-30% away from your entry price.
Rule #10: Place a very distant profit target.
Breakouts are one of the most important elements in your trading toolbox
As these types of long-term trades don’t come along very often, be sure not to waste them.
- Enter without fear.
- Channel your inner trend-follower and be happy sitting through pull-backs.
- Take profit when the opportunity presents itself.
- Manage risk when needs be.
Until next time.
About the Author
Sam Eder is a currency trader and author of the Definitive Guide to Developing a Winning Forex Trading System and the Advanced Forex Course for Smart Traders (get free access). He is the owner of www.fxrenew.com a provider of Forex signals from ex-bank and hedge fund traders (get a free trial). If you like Sam’s writing you can subscribe to his newsletter.