What Exactly Is a "False Breakout"?
Student’s Question:What exactly is a “false” breakout? Thanks.Instructor’s Response:Take a look at the first chart below…
In order for a breakout to occur, a range must first be present. (Also, a breakout can occur above an established level of resistance or below an established level of support.) As we can see, price action moves within the range for several months and then begins to build a series of higher highs and lows. This time (around the end of November) instead of retracing as resistance is approached, a candle trades right through it and closes well above the top of the range.Looking at MACD, we can see that this breakout will quite likely be sustained as the indicator is giving a very bullish signal.On the second chart, however, we can see where price action has “wicked” above the top of the range but the candle did not close above the top of the range represented by resistance.
For the time that price was trading above the top of the range, traders may have believed that this indeed was a breakout. The “breakout”, however turned out to be false. This is why it is critical not to base any trading decisions on an open candle. We must wait for the candle to close otherwise we do not truly know what configuration it will ultimately take on.On the right hand side of the chart we can see where a candle closed below support then a doji forms and then, potentially, price action might close back within the range. Should that in fact occur, this also could be termed a “false” breakout since there was no follow through after the initial breakout as was noted on the first chart.
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