Breakout Fading (Part I)

Suppose you believe that the currency prices will not be able to follow through action in the direction of the breakout. Fading breakouts refers to trading against breakouts. When we believe that breakouts from support and resistance levels to be false and unsustainable we fade breakouts.

False breakouts are also known as fakeouts. False breakouts are a bane for breakout traders but boon for breakout faders. Fading breakouts tends to be more effective as a short term strategy. It is not meant to be a long term strategy.

Support level attracts the buyers enthusiasm for higher bids. It prevents the price from falling further. The resistance level attracts the sellers enthusiasm for shorting and it prevents the price action from advancing higher. Support and resistance are seen as the price floor and the price ceiling respectively.

The crowd likes to trade the breakout. The idea of trading breakouts appeals to many independent traders especially those new to currency trading. It is perfectly logical for the crowd to think that if the support level is penetrated, then the price action should move downward. The crowd is more likely to sell than to buy.

The opposite is true of a price break above the resistance level and the crowd usually concludes that if the resistance is broken, then the prices are more likely to advance higher in the rally. Hence, the crowd is more likely to buy than to sell when the price action breaks the resistance level from below.

You will find clusters of stop loss orders placed around both the support and resistance levels. These stop loss orders are placed by traders who have brought near the support level or have sold near the resistance level. Now you can also understand why there tends to be large number of entry stop orders placed just above a resistance level and also placed just below a support level.

So when the price action breaks out above the resistance level, short positions will be stopped out. Similarly, long positions will be stopped out when the currency prices crosses below the support level.

You will ask why most breakouts fail? The fact that smart traders need to take the money from the novice and inexperience traders is one of the most important reasons why most breakouts fail. Always remember, it does not always pay to have the same mentality as the crowd. The majority will cash out of the trading game broke.

Smart money belongs to the big players who have a couple of tricks to sabotage the crowd. The crowd holds the dumb money with the weak hands. Money has to be made from the majority. Not from the minority who got it right and know how to play the games.

When the crowd scrambles to get out of their losing positions, it causes vertical rallies or declines. The most money is made when the crowd turns out to be wrong. Read Part II for more.