How to Trade the New Trend after a Breakout
Cory Mitchell, CMT
A price structure is when we can draw trendlines around price movements (high highs and lows) and the price is bouncing between those trendlines. A range, wedge, channel, triangle, and expanding ranges are all examples of price structures.
Many of the trade ideas published on this site are based on price structures. Typically, trades are based on the assumption that the price structure will continue. For example, we may short at the top of a range, or buy near the bottom of an ascending channel.
We wait for an entry signal near the trendline or expected area of resistance/support. An entry signal occurs when the pair shows evidence that the price is moving off the resistance/support (edge of the structure) and back toward the other side of the price structure.
This method was covered in How to Find High Reward Trades Based on Price Structures. The video below summarizes the concept.
But the price doesn't always, stall and reverse near the edges of the structure. Sometimes the price keeps moving beyond these levels, called a breakout. So the next stage of the strategy is learning what to do after a breakout. That concept is tackled in this article, below the video.
Trading Price Structures After a Breakout
If a breakout happens, I let it go. There are a couple of reasons for this.
- At the edge of the structure, I am calculating reward:risk ratios for if the price structure continues.
- The price may breakout out initially, but it could be a false breakout. In that case, I still want to stay focused on the price structure trade. I don't want to be flipping long, then short, then long, then short for example, as the price chops around near a price structure edge.
- IF an actual breakout occurs, and the price runs well beyond the prior price structure, there will likely be a new trading opportunity, in the new trend direction, soon.
That last point is the focus of this article.
Once a breakout occurs, the price has shown that it had enough force to break out of the prior price structure and is now likely trending in the breakout direction.
Following the breakout, we can then look for a shorter-term price structure that shows how the price is trending (I use the 1-hour usually).
Before we can have a breakout, there needs to a price structure to break out of. The NZDJPY was a pair discussed in the Trade Ideas when it was in its range.
While the price is in the range, I commit to looking for longs near the bottom and shorts near the top. I am not concerned with a breakout at this point.
After a Breakout, Define the New Price Structure
While a breakout is possible, I don't concern myself with UNTIL AFTER it happens.
Once the breakout occurs, I can then look for the trend in the breakout direction. For example, in the price breaks out of the top of the channel, I look at the uptrend that started at the bottom of the channel and has now continued above the channel.
Draw trendlines along the trend, or a regression channel works well and is what I commonly use.
On the chart below we can see that the price did indeed break above the top of the range. I want to see the price move well beyond a price structure before I consider it a breakout.
I have drawn a regression channel from the last swing low up to the most recent price bar. We now have a price structure for trading the trend that the breakout generated. Prior to this, the range was the dominant structure, but with the range broken, this new structure becomes the one to focus on.
With the new price structure drawn, look for trades near the edges. For example, on the chart above, look for a long trade signal near the bottom fo the ascending channel, which also is near the bottom of a short-term range. [You can draw the channels within larger price structures anytime. They may help you find some other short-term trading opportunities.]
The red and green boxes mark trades: red is the difference between the entry and stop loss, and the green is the difference between the entry and the profit target.
The two red and green boxes drawn on the far right are hypothetical trades, since the price hasn't given a buy signal yet.
Based on the strategy, and the pre-trade checklist, during an ascending channel we can place a profit target just above the prior swing high. But we also have a short-term range, so the green boxes mark the two potential profit targets (chart above). When two options are present, consider exiting half the position size at the first target and the remainder of the position at the second target.
Note that price action can change. Update your price structures as the price action unfolds.
If there is no discernable price structure, then don't use this strategy!
Here's a video on trading the price structure after the breakout (includes a few extra tidbits not included in the article).
Early Exits, Trailing Stop Losses, or Leave Alone?
A good entry with small risk can result in huge reward-to-risk trading opportunities.
There are many different types of trailing stop losses. Some may work better than others, but all of them will end up kicking you out of many trades before the big win is attained. Although, you may lock in a few more small winners compared to doing nothing with the trade (letting it hit the original stop loss or target with no trading stop loss).
Before using a trailing stop loss, consider this:
No matter how the trade moves, your maximum risk is 1R. If you get out of a trade early, you could be giving up 2R, 5R, 10R! The amount you could be giving up is almost ways way bigger than what you could lose.
R just means a risk unit. For me, R is 2% of my account. So the risk on each trade should equate to 2% of my account. Therefore, my reward to risk is simply a multiple of risk. This is discussed in the position sizing article.
Lessons from the Published Trades in May revealed that leaving the trades alone was better than using a trailing stop loss. The possibility that the trailing stop loss cuts your winners short means missing out on way too much profit potential. Plus, leaving the trades alone is the easiest. Set the trade and then forget about it...you don't need to (and probably shouldn't) even look at it. Plus, actually capitalizing on those huge reward:risk trades every once in a while can produce BIG monthly returns.
Other Related Articles
Throughout the article above, I have linked to other relevant articles. Explore those for more detail on different concepts of this strategy.
You may also wish to read up on:
- Which Forex Pairs to Trade
- What to Know About Holding Trades Through the Weekend
- There is a lot to remember with any strategy. Creating a Daily Routine can help immensely with reinforcing certain habits.
By Cory Mitchell, CMT @corymitc
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.