Guest Post by: Colibri Trader
Why Trading Breakouts Might be Too Risky
In the FOREX market currencies from around the world merge to trade 24 hours, and for traders of all levels who participate the sky is the limit in terms of success. It can happen any time, as the opportunities are vast. Armed with the technical knowledge and careful analyses one can earn a hundred pips in just minutes. Unlike traditional businesses that have regular business hours of operations, (and the peak hours are limited), the foreign exchange market lets a trader pick up on a trend and take advantage of an economic surge any time of the day, from any point in the world.
Traders in banks and other financial institutions win or lose millions of dollars in minutes. The fault of most traders coming in the business is that they become too eager to earn profits, and end up gambling it all away. And it is not really too far from gambling in essence, especially if one becomes too impulsive in his/her decision making. Some traders are too aggressive as they subconsciously become too greedy. They overlook general signs in the market that would normally function as red flags against reversions when prices advance quickly. While it is tempting to ride along a big trend, it is also very important to remain patient and buy time. It is even better to take a short break so one is able to have an objective view on the markets.
One of the strategies that traders in the FOREX field undertake is to take advantage of trading breakouts. An alternative way to trade in a volatile market is by trading the range. One is able to measure risk better and enter more precisely in a trade. There is a better risk:reward ratio and one can place tighter stops. When a trader trades the range the reward is viewed to be higher than the risk involved. It is a very safe business mentality, that actually makes sense especially for the long term. However, some traders are not patient enough and are insatiable in their quest for higher profits. In case you want to utilise a breakout strategy, you can always use part of your capital for it and the rest on a range-trading strategy.
Why does so many traders choose to trade breakouts, then? The reason lies in our nature- traders deviate most of the time between greed and fear. When EUR/USD is piercing through a resistance, the urge is to take advantage of this surge, where one’s capital might double on a single move. It all sounds good, until you start accumulating one big loss after another, and losses do lead to more losses.
Many amateur traders fall victims to the idea of trading breakouts thinking that they will be able to reap dividends from their trades quickly. Without taking heed of many factors involving a trade one can get careless too quickly. Trading breakouts happen from time to time, but it does not necessarily mean you need to try getting in all of them. In fact, there are great chances these uptrends would just revert back within the range. These are also known as false breakouts. Traders trading breakouts usually protect their positions with stop-loss orders, and think that justifies aggressive trading. It is always wise to remember that valid breakouts rarely occur in the FOREX market- in fact less than 20% of the time. Although trade breakouts pop up at times, there is a huge chance this move will be followed by a correction, and price will revert back to the breakout level.
TRADERS who are not patient enough, or jump in at the first sight of a breakout often lose money badly. They expect a sudden rise in their trades only to fake out and plunge. That is where the pro traders come in as they are chasing the stops. These false breakouts give perfect opportunities for traders trading the range to take advantage of- just like the EUR/USD image above. And that is where it is best to take action- usually using price action. It is always better to wait for things to settle down and for your setup to form. Be patient and observe closely the price action on the higher timeframes. It always pays back to be patient and observant in the FOREX (and other) markets. But even if such is the case, this does not necessarily mean that you have found the holy-grail. Remember that FOREX trading can be very tricky, and could be equivalent to gambling if you don’t follow strict rules. Professional traders do follow such and are not tempted from all opportunities. They are patient hunters waiting for the best opportunities only.
In times when things don’t look too rosy, traders may resort to shortcuts in order to cut down on the decision making. In other words, traders are trying to apply psychological filters hoping to turn back to profitability, but usually it does not work this way.
It is ultimately one’s unrealistic targets that trigger losses by chasing the trading breakouts. One becomes vulnerable by risking a lot to get a lot in return. With this kind of approach a trader is liable to lose more in the end, if not everything. It is always best to take your time, wait for the news (e.g. interest rates decisions) and analyze the data. Wait for the best setups around important levels, which may seem boring to most of you, but it helps you grow your profits in a consistent way. Remember that the chances of a breakout are very low, and they are highly dependent on external factors that affect the market.
There are various ways to approach the market and trade it, but breakouts do involve a lot of things that are beyond our control. There are just too many variables, and trading is not an exact science. Think differently, as a trader you do not always have to go where others tend to go. If prices go in your direction it does not necessarily mean it will always go that way. Chances are that prices will only deviate between two boundaries for over 80% of the time. Remember, too, that false breakouts reduce your profits, and in the long term they could mean losing your capital.
Chasing trading breakouts is a losing game over the long haul, although it does sound fun. Still the more reasonable way to trade FX/CFDs is to buy or sell around major levels using pure price for indication. It is better to be safe than sorry. Only go for it if the trend clearly indicates that. More often than not, going for trade breakouts that are “too obvious” ends up to be an obvious loss. This being said, it does not necessarily mean that a trader should never go for it when a trade breakout appears. It is only highly recommended to take things into consideration first, wait for the breakout, and finally trade only when a trend forms. In the meantime, you should not lose patience while you are waiting for the best setups to form. Use price action as an indication and ideally just trade around the major levels. In the end- what is a little bit of time in exchange for a peace of mind?