Many traders will attempt to initiate a position as the market breaks out (trades at a new high) or breaks down (trades at a new low). The reason being, many times if the market makes a new high it has the tendency to move significantly higher. However, the problem with this strategy is that often the market will trade at a new high, only to fall back down inside the trading range. When this occurs, the trader ends up buying the highest price, only to lose money on the trade. One way to avoid this problem is to wait for ‘confirmation’ in the trade. For example, if the market truly breaks out to the upside, the former ‘resistance’ line ‘should’ become the new support level. One way to execute this trade is as follows…
1. Wait for the market to break out of its range. Traders will usually wait for a complete candlestick to ‘close’ above the resistance level.
2. If this occurs, we can then initiate a position when the market pulls back to our new support level. We should pay special attention to the candlesticks at this point, and look for signs that it will not fall back below our (new) support level. A long wick which touches the new support level (previous resistance) and then closes well above support would be an ideal signal.
3. Traders will typically put protective stops under the support line. The rational is that if the market falls back inside the range, the breakout was nothing more than a false breakout. The opposite also holds true. If support is broken, this same price level may now become our new resistance level.
Matt Russell is a Trading Instructor here at FXCM. He regularly contributes to the Weekly Trading Lesson, Instructor Trading Tips, and creates a daily trading video called London Calling. To receive more timely notifications for his articles or videos, email firstname.lastname@example.org be added to his distribution list.
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