How to Identify Opening Range Breakouts (…and not fakeouts!)

...learning to be patient after a breakout, and waiting for pullbacks.

5 minute read

Logical analysis would infer that opening range chart breakouts would seemingly be the most low risk entry method for a wide range of trading systems, so why is it that more people don’t adopt this entry method which provides the ultimate confirmation signal? The main reason is that the vast majority of traders don’t have anywhere near the level of patience required to become proficient at using this technique. In fact, it is true to say that a substantial percentage of traders, especially newbies, over-trade in the markets by quite some margin.

Opening Range
The markets have a way of making you feel 100% confident in your convictions, and acting in a way that confirms you were right, before turning around and moving strongly against you. Professional traders have an uncanny ability to spot the genuine moves from the fakes.

Trading breakouts requires a good understanding and implementation of technical analysis, otherwise what can appear to be a breakout on one individual’s chart, can simply be the price stretching to an extreme margin on somebody else's. Price can break out through trading ranges, trend lines, support and resistance levels, and various other technical chart drawings which attempt to make sense of price action by ‘containing’ it within a set of boundaries, in one shape or another.

 

When price breaks out from a trading range it will more often than not spike up and close through the range, before pulling back to the area where the range was broken, and then accelerating sharply away. Chart breakouts can hold tremendous energy and move the price far away from your entry point in a very short time span making them a superb technique for intraday trading. After the initial burst there can be a small pullback, which is often a bull or bear trap as inexperienced traders anticipate price to move back down toward the range, only for their stop losses to get taken out and fuel another surge in the opposite direction. This can happen three, four or even more times before the price is finally ready to reverse.

 

The most important factor when trading this method is to wait for clear confirmation that the range, or whichever way the price is being contained, has been broken, and then demonstrate even further patience by holding for a substantial pull back before taking up a position. These events are relatively rare to spot in a live trading scenario, but are equally difficult to set up any kind of alert for; the price can pierce through a trading range and have you convinced beyond any doubt that the range has been broken, only for it to pull back down and remain range bound; this is what’s known as a fakeout.

"What is ideally required is a way of your account alerting you when the price has closed through the range by an optimum percentage number, which you can then manually assess, and decide whether to enter when the price pulls back."

Price breakout behavior can also occur when a chart pattern does not come to fruition. If a chart sets up to appear as if it is forming a popular pattern like a double top, it will encourage many traders to speculate in that area of the chart. If the price then moves against those traders, and nullifies the pattern forming, those traders stop losses will be triggered and cause a large and sharp price move.

 

The traders who were anticipating, or speculating on the fact that the chart would develop into a double top, in this instance, are using far more guesswork than I would advise, you should trade the current price action only, not make a bet on what you think will happen based on past events. Professional traders wait for the price action to demonstrate that other individuals are in a position of weakness, and then take up their position in the opposite direction to these trigger-happy traders, and ultimately help move the price to a place where the weak traders positions get closed out by their stop loss getting hit, or by way of them throwing in the towel on a losing trade.

 

In addition to trading the breakouts themselves, it is true that speculating on the fakeouts which take place can be equally as (if not, more) profitable. If you have spent any time trading a live account you will have noticed how fakeouts are commonplace, and that for the price to break out of a range is actually quite a rare event. Trading chart fakeouts means that you can take up a position on the outermost extreme margin of a trading range and maximize your profits, it also allows you to use a really tight stop loss, since if the price has already pierced through the range and then continues to shoot much further, then your instincts will tell you it’s time to close that position out for a small loss.

 

There are no set rules to determine when the price is making a fakeout or a genuine move away from the price range, and lagging technical indicators such as stochastics, relative price index and the average true range will likely only make you more confused in your decision making. It’s only time and experience in live market conditions which will enable you to hone in your abilities to trade these methods effectively, and the great thing is that you will be trading live price action as opposed to making predictions and trading on guesswork.

 

Markets can be in trading channels for large periods of time, and by learning how to trade both fakeouts and authentic chart breakout moves, you will give yourself a fantastic opportunity to profit consistently. Furthermore, taking up positions in these areas, when price is acting in a range bound fashion means you will develop the skills required to learn how to trade in-step with the market rhythm. This is crucial for every trader’s progression, and whilst trend following techniques can be used some of the time, your bread and butter can most certainly be made trading market ranges.

 

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