Trading Strategies On Breakouts And Reversals
Support and resistance levels are key tools used in technical analysis by traders to identify potential buying and selling opportunities in the market. As we learned so far, these levels are formed based on past prices of an asset and help traders to determine the future direction of the asset's price movement. Here, we will discuss how traders can trade support and resistance levels in the case of a breakout and reversals.
Remember, while support and resistance levels are important in technical analysis, for real trading, you should also consider other tools and factors like market trends, waves, patterns, price action, and economic situations and indicators to create a proper trading strategy.
Breakout
A breakout occurs when the price of an asset breaks above or below a key support or resistance level. Traders who use breakout trading strategies aim to profit from the price momentum that occurs after the breakout. Breakout trading is a popular strategy because it allows traders to enter trades at the beginning of a new trend, which can lead to significant profits. However, entering the trade at the correct time also determining the breakout from the fakeout can be hard. Choosing a proper stop loss and take profit point also plays a great role in these strategies and money management strategies.Another key point in this strategy is confirmation. Traders who use breakout strategies can use a variety of techniques to help them confirm the validity of the breakout, including volume analysis, time frame analysis, and technical indicators. For example, if the volume is high when the price breaks through a support or resistance level, it can suggest a genuine breakout. Similarly, if the price also breaks through on a longer time frame, it is more likely to be a genuine breakout since this reduces the chance of fake outs.
One common breakout trading strategy is to wait for a pullback or retest. This method involves waiting for the price to break through a significant support or resistance level and then waiting for a retest of the level before entering a trade in the direction of the breakout. The retest offers traders an opportunity to confirm that the breakout is genuine and helps to reduce the risk of a false breakout.
GBPUSD, Daily chart (2021 - 2022)
Reversal
When the price reverses from a support or resistance level, traders can take this as a trading opportunity. The overall idea of this approach is known as buy low, sell high. This is a basic trading strategy that involves buying when the price is near a support level and selling when the price is near a resistance level. Some traders use technical indicators to confirm when the price is oversold or overbought, respectively. When the price approaches a support level, traders can look for bullish signals like a bullish candlestick pattern or a bullish divergence on an oscillator. When the price approaches a resistance level, traders can look for bearish signals like a bearish candlestick pattern or a bearish divergence on an oscillator.
Additionally, Traders can wait for a reversal pattern to form on the chart before entering a trade. Common reversal patterns include double tops, double bottoms, head and shoulders, and inverse head and shoulders. These patterns typically indicate that the price is about to reverse and can provide a good entry point for traders. It's important to wait for the pattern to complete before entering a trade.
Besides, Traders can use price action signals like pin bars, inside bars, and engulfing patterns to enter trades when the price reverses from a support or resistance level. These signals can provide a good indication of market sentiment and can help traders identify potential trend reversals. Traders can also use trendlines to confirm price action signals and enter trades when the price breaks above or below a trendline.
As an additional tool, Traders can use Fibonacci retracements to identify potential support and resistance levels. Traders can use Fibonacci retracements to identify levels where the price is likely to find support or resistance and enter trades accordingly.
Fakeout
Fakeouts do not necessarily signal a strong reversal. However, in some cases, a fakeout can signal a potential trend reversal. This can happen when the price breaks out of a support or resistance level, luring in traders who expect the trend to continue, but then quickly reverses direction, indicating that the trend may be losing momentum. In all these cases, traders should look for confirmation before entering a trade as described above about reversals.