“Busted” or “failed” breakouts provide a nice edge to currency traders.

The tendency for currency pairs to respect and reverse off key levels means that you can look for opportunities to trade failed breakouts.

This type of trading is not for the faint-hearted. By their nature, busted breakouts are contrarian, meaning you will get stopped out consistently.

But the good news is that when you do get a winner, it will have a superior risk/reward ratio.

Let’s look at exactly what a busted breakout is.

How to identify a busted breakout

To identify a busted breakout, look for two things:

1. A persistent range.
2. Support and resistance levels.

Wait for a period of sideways price action, and then a failure to break out of the range. This failure is often accompanied by a candlestick reversal pattern.

This should be at a point where the price has failed to break before (a support or resistance level).

Here is a busted breakout on the AUDUSD.

Note, that if the support or resistance level is major enough, then the price may move towards it and reverse suddenly without the formation of a range.

Here is one on EURGBP.

You can see price was attracted to the level and rapidly reversed once it was taken out.

How to implement the trade

It’s best to keep it simple when you implement these trades.

Wait for the close of the reversal candle and enter your position at market. You can then put your stop-loss slightly behind the entry candle.

Here is an example on GBPAUD.

Another here on gold.

You can see that while you need to be brave to take a position against the trend, it will give you the opportunity to make a large R-multiple return.

Some tips for making it work

While it can be easy to look at a few examples and think you have a winning method, the reality is a bit different. Here are a few tips.

Be patient and wait for the range to be completely busted. You can see what I mean here on the earlier example on AUDUSD.

Make sure you have a method for letting your profits run. You will want to be making 3R or more on your winners. Check out this lesson on complex exits for more.

Busted breakouts occur across multiple timeframes. They are useful for both short and long-term traders. But don’t try to trade everything. Pick your best timeframe for trading busted breakouts and focus on it.

Busted breakouts of wide ranges are better. A failure of a low volume breakout is not going to provide you with a great trade.

Be courageous! Often these trades will be against the current trend and sentiment. Be prepared to trade the price action alone, and ignore the fundamentals or what other people are thinking.

Practice makes perfect

If you want to get good at trading busted breakouts, it won’t happen overnight.

Practice, take notes, review what worked and what didn’t, and over time you will develop a consistent trading methodology that is going to deliver you some very big wins.

Cheers,

Sam

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.