Talking Points:
-SSI readings move from extreme levels to neutral
-Rate of Change analysis shows consolidation of previous trend
-The bias towards breakout strategies is favored cross pairs such as AUD/JPY and EUR/AUD
The DailyFX Plus Breakout2 strategy is one of the more popular strategies followed. Because it trades breakouts with a sentiment filter, the strategy tends to work well in volatile market conditions.
Over the past week, we have seen volatility contract on many pairs while the Rate of Change indicator became mixed. Additionally, the SSI (Speculative Sentiment Index) has become less extreme. This suggests a consolidation of previous trends.
For many of the pairs, those are the ingredients that are not favorable for a breakout strategy. However, there still are some opportunities in pairs such as AUDJPY and EURAUD as the technical picture suggests the ingredients exists for a breakout to follow through.
As we can see above, prices have been contained above the support trend line. In late January 2015, prices bounced again from this support line suggesting the trend is to the upside. SSI for the pair continues to be deeply entrenched with a majority of sellers as traders look to sell anything Euro.
However, trends don’t move in straight lines and don’t last forever. The EURUSD SSI shows a large number of short traders while the EURJPY SSI has moved to neutral. Therefore, do not be surprised for a Euro bounce to continue and the EURAUD will be a vehicle to consider for that bounce.
Keep in mind, that a trader will be paying a daily roll to hold long Euros. Fortunately, the Breakout2 strategy has an SSI filter.
As a result, the EURAUD and AUDJPY are two currency pairs favored for trading the Breakout2 strategy. (Those currency pairs with a conviction rating of ‘3’ represent market conditions that are ripe for breakout trades.)
DailyFX Plus Breakout2 Conviction Chart for February 6, 2015
| ADX | ROC | Volatility Expansion? | Sentiment | Conviction | |
|---|---|---|---|---|---|
| EURUSD | Trend | Neutral | Yes | Bullish | 2 |
| AUDUSD | Trend | Bearish | Yes | Neutral | 2 |
| GBPUSD | Trend | Bullish | Yes | Neutral | 2 |
| NZDUSD | Trend | Neutral | Yes | Neutral | 1 |
| USDCHF | Range | Neutral | No | Bearish | 1 |
| USDCAD | Trend | Neutral | Yes | Neutral | 1 |
| USDJPY | Range | Neutral | No | Bearish | 1 |
| EURJPY | Range | Neutral | Yes | Neutral | 1 |
| GBPJPY | Trend | Bullish | Yes | Bearish | 1 |
| CHFJPY | Trend | Neutral | No | Bullish | 1 |
| AUDJPY | Trend | Bearish | Yes | Bearish | 3 |
| EURAUD | Trend | Bullish | Yes | Bullish | 3 |
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Though this is written with the Breakout2 strategy in mind, the information contained can be applied to intraday breakout strategies in general. To trade manually, simply analyze the support and resistance levels and buy a break of resistance or sell a break of support.
As you can see in the chart above, the ADX and Rate of Change (ROC) are grouped together. Since the ADX doesn’t indicate direction, only strength of move, we want to couple it with a rate of change indicator.
When trading a breakout strategy, ideally we would like to see prices in a trend and moving. This would increase the chance of a breakout that would follow through. If prices are in a range and if the ROC is neutral, that indicates prices are comfortable near the current levels.
Ideally, when trading the Breakout2, we would like to see a directional move take place with expanding volatility.
Expanding volatility can be measured through analysis of ATR range or perhaps volume expansion.
The fourth analytical item is sentiment as read through SSI. The result of the “Bearish” means the SSI reading is > 1.22 and “Bullish” means SSI is <-1.22. For a current reading of SSI, log into DailyFX Plus and view the Speculative Sentiment Index section (SSI).
When taking this together a conviction reading is assigned. It is important to understand the conviction reading is the opinion of the author and not a recommendation to trade, use, or not use the DailyFX Plus Breakout2 strategy.
A conviction rating of ‘3’ means the ingredients exist for a breakout market condition that the Breakout2 strategy enjoys. A reading of ‘1’ represents a mixed bag and that the Breakout2 strategy is more at risk of a market condition that doesn’t cater as well to breakouts.
For example, the AUDJPY was given a ‘3’ conviction due to an extreme SSI reading of 3 with a strong trend in place.
Therefore, the conditions exist for a potential follow through of a breakout in the EURAUD and AUDJPY if a breakout trade sets up.
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
The DailyFX Plus Breakout2 strategy can be automated. If you wish for the trades to trigger automatically into your account, register for a Mirror account which provides you access to dozens of other strategies as well.
Follow me on Twitter at @JWagnerFXTrader.
See Jeremy’s recent articles at his DailyFX Forex Educators Bio Page.
Feedback? Email Jeremy at jwagner@dailyfx.com
