Introduction to Breakout Trades
Trading a breakout is simply the act of entering a position when price breaks above/below an area of support/resistance or breaks out above/below a consolidation area or correction. Executing a breakout trade can also be considered as directional trade confirmation, i.e. confirmation that a trend may have resumed.
However, when it comes to executing any particular strategy, careful consideration should be taken whether the right trading conditions warrants the use of such a strategy. Not all strategies work all the time under all conditions and that includes breakout trades.
In this article, we will look at when the best times are to implement the breakout strategy, so that traders who are familiar with the Exponential Profits System (EPS) strategy can benefit from such trades when the right conditions arise again.
Dangers of Breakout Trades
Throughout this article we will be using Gold as our prime example to explain the dangers of breakout trades first and then show you later when it makes sense to attempt a breakout trade.
The chart above is that of Gold on the daily timeframe. We can see that Gold ended a long term downward trend at the end of 2015 when it broke above a downward sloping trend line. Looking left on the chart we can see that Gold started running into resistance (orange box) when it reached an area of previous market structure and again most recently during 2018 (red box).
The red arrows show how many times traders would have run into trouble if they attempted to trade breakouts higher.
The mistake that many traders make when trading a breakout, thinking that price would go to new highs, is that they are entering at the wrong time when trends are exhausted, just to be surprised when price reverses against them and stops them out.
Knowing when a trend is coming to an end is very hard to predict and is why we prefer to trade the end of corrections within a trend with our EPS strategy because they are lower risk setups.
The most recent area of resistance in Gold lies between the 1350 – 1365 area and traders who have attempted breakout trades (last two arrows) would have lost money on two occasions. This is what is referred to as a bull trap because traders get lured into thinking that prices would break out higher, just to be met with increased selling pressure from institutional traders selling against them. Breakout trading can also help traders avoid certain trading hazards, such as the risks posed by trading psychology.
EPS Strategy Setup
Knowing that we teach to trade the end of corrections the first big setup for this year in Gold, appeared on the 1st March 2018 after an A-B-C type of correction that ended at the lower blue median line of a Schiff pitchfork.
The problem was that we were hoping for price to reach a lower area, so we did not trade that low but if you did trade that you would have made some substantial profit on the way up with proper trade management techniques, even though price did not go to new highs.
On the 17th May 2018 we presented the above detailed Elliott wave count on Gold, which we identified as a possible expanded flat correction. The reason why we identified this correction as an expanded flat was because price never broke the January/February highs and it was possible to count the move higher as a correction and not a continuation of a trend.
This is typical of an Expanded Flat correction, 3 waves down, 3 waves up followed by 5 waves down to complete the entire correction in a C wave.
During that forecast on the 17th May we noted that we would want to see price move even lower towards the lower red warning line of our Schiff pitchfork and we identified a price zone where the 5th wave of the C wave could possibly end.
The reason why we would look at taking breakout trades as an option next, is that what if the 5th wave of the C wave already ended? The way things currently stand it is certainly possible to count 5 waves down and although the possibility exists that price may go as low as our original forecast we do not want to miss out on the start of a potentially large move upwards.
Taking Breakout Trades as an Alternative Setup
On the 5th June 2018 we issued a breakout trade setup at the 1300 level, only because there is a chance that the larger Expanded Flat correction ended already.
Note that this is not a breakout trade at the highs of Gold but a breakout setup in close proximity to a low that we think might be the end of a correction.
We placed our stop loss below a previous higher low and now it’s simply a waiting game to see whether we are right or not. Trading involves taking risks but if you manage your position size properly, according to the risk you are taking on, then taking these sort of breakout trades we are proposing could become a profitable alternative.
The downside to taking breakout trades is that our stop losses are much wider than our end of correction type setups, so we propose that traders consider these trades as an additional EPS strategy setup which they can choose to trade if they are comfortable in using larger stop loss orders. This way we may be able to book more trades more often especially if we think that we have missed the end of a correction.
Trading breakout trades at the highs or lows of important previous market structure, especially when viewed on a larger time frame such as a daily chart can be very difficult but when you attempt a breakout trade near the lows (using Gold as an example) after you think a correction might have ended and you possibly missed it, is much wiser and safer.
The order we placed at the 1300 level after the 5th June EPS Forecast report was intended to act as a breakout trade after what looked like a minor A-B-C that ended with a higher low at the lower blue median line of a Schiff Pitchfork.
Placing a breakout order at the 1300 level was also intended to act as directional trade confirmation that price was getting ready to move higher. At the time of writing this article price continues to move sideways but if it does break higher with some increased momentum we would at least be in this trade with a good chance of making some profits.
We hope that our new additional breakout setup will be something you consider as a trader and although there might not be too many of them moving ahead, we believe that the reasoning behind taking trades like these and the way we do it, justifies the wider stops used and that it would avoid us missing potentially large moves in the markets.
Until next time,
All the best.