The new highs and lows registered by EUR / USD represent a very interesting price threshold to various types of traders. From a mechanical point of view, the ability of a market to overcome a previous top or violate a previous bottom, represents a strength signal (or weakness) in the direction of the breakthrough. Some price levels, often placed at standard values as 10, 20 or 50 days, are constantly monitored either by traders who are looking for medium-term trend movements or by those who wish to speculate on the possible breakout reverse reaction for a short or very short operability.
It is quite obvious that a trend begins from a breakout. Therefore, for any market, developing a strong trend means the constant violation of a previous top (or low).
The theory behind the strategy of trading based on the breakout argues that, if a market is able to reach new highs, in fact, it is proving to be strong enough to create a long lasting trend and this is especially true for the FOREX where it is impossible to measure the traded volumes. Obviously, the more significant the violated price level is, the stronger the directional movement will result.
For example, an exchange ratio that exceeds the previous top at 10 days does not necessarily provide a strength signal to assume the beginning of a strong trend. On the contrary, the overcoming of a previous top at 50 days is indicative of a greater force by the market. The following figure shows clearly that the violation by USD/ ZAR of the top at 50 days had a very important strength because it violated some resistances already pressed.
Forex Trading Breakouts
A classical technical figure based on the break out is the head and shoulder one. For example EUR / USD in the months between January 2012 and May 2012. The market trend was bearish, but in that moment EUR / USD began a trading range phase with the formation of a left shoulder at 1.3322, a head at 1.3487 and a right shoulder at 1.3386. The neck line was represented by the union of the primary tops inside the figure, or 1.2974 and 1.3004. On May the 9th 2012, the neck line was broken with a strong break out in the closure, as it was going to break downwards a support that had already prevented the market to go down. At that point, the trader should have opened short positions of EUR / USD with a stop loss at 1.3386 (which is the top of the right shoulder) and a target equal to the difference between the top head (1.3487) and the neck line (1.30). 1.2513 was therefore the objective of this trade, reached on May the 24th.
Breakouts strength in currencies trading
Another classical figure based on the break out is linked to the formation of double top or double bottom figures. A concrete example can help understanding how to define price targets in the formalization of certain technical figures. Let’s check AUD / USD between May and August 2011. AUD / USD recorded a first top at 1.1012 on May the 2nd. There was then a correction till 1.0391 before a new rise. Once again, the area concerning 1.107 recorded a top, but the strength of that resistance prevented Aussie to go further. The next fall was very deep and on August the 8th, the market fell below 1.0391, a particularly strong break out due to the importance of the support. At that point, many aggressive traders could get short, while the most prudent traders decided to wait for a retracement, which actually arrived. The support break out helped the start of a bear market where the lowest target was measured by the difference between the top (1.107) and the low (1.039), starting from that level. The objective of the bearish chart was therefore 0.9710 which was the level reached on October the 3rd.
Forex trading with breakouts
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