As discussed, markets are great at presenting fake signals, so it is important to look for confirmation of a breakout. Without any confirmation sign, it is likely that the breakout will fail and become a fakeout like the one we saw at the turn of the month.
In short, a false breakout happens when the price breaks above or below a resistance level, trend line or area of interest, but then fails to hold it. This usually happens because either the area was not as significant as the trader thought or large players engineered the breakout to fill their orders.
How to Identify False Breakout (Fakeout) Trading Patterns?
Telling real and false breakouts apart is a very difficult process. In fact, false breakouts are often engineered to look like the real deal to lure traders into taking wrong positions. Nevertheless, there are a few things you can do to improve your accuracy.
Firstly, the obvious move is to wait for a few candles to close before positioning yourself. The longer price holds above the breakout area, the more likely it is to be a true breakout. In combination with this, zooming in to lower time frames is another place to look for extra confidence. The low time frames will — in the case of real breakouts — often print a quick retest of the breakout area before continuing further. They will also warn you early when the price starts to close back below the level. In any case, candle closes are a solid confirmation indicator.
Studying the current environment is also a great source of information on the authenticity of a breakout. In a bearish environment, breakouts have a higher chance of failing, so fake outs are more common. Bull markets are more likely to turn attempted breakouts into success.
Finally, as already discussed at the start of the article, volume is a great indicator to follow as well. Usually, strong breakouts happen on higher-than-normal volumes.
Using (False) Breakouts to Confirm Trade Ideas
Now that we know what to look for, we can use these signals to confirm trade ideas. If trader Fred already has a bearish outlook, he can look for a false breakout to enter his trade and add more confidence to his already bearish thesis.
The same is true for trader Julia, who believes Ethereum will go up. She looks for a failed breakdown to enter her long trade and to add confidence to her already bullish trading plan.
