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Why You Should Love The False Breakout When Futures Trading (Not Hate It)


There aren't many things that frustrate futures trades more than a false breakout. The price moves above (or below) a level you expect will cause a further rise (or fall), only to watch in horror as the price almost instantaneously snaps back the other way. False breaks are prevalent in all markets, including futures markets.

Before a big move the price will often make a "fake out" move in the opposite direction, causing inexperienced trades to abandon their positions and watch in frustration as the price then proceeds to do as expected...without them.

On March 25 a potential way to trade the sharp reversal in corn was proposed. The possible setup occurred following a sharp rally which created a bullish bias, but the strategy called for a correction to the downside, followed by a consolidation and a break above the consolidation high. Those conditions materialized between March 31 and April 1.

Figure 1 shows the false downside move that occurred just prior to the price moving higher (as well as some other false breakout which occurred prior). This move lower trapped a lot of traders; they either went short or bailed on longs which had been accumulated in the last 24 hour (or longer). The price then rose sharply, causes losses for those that went short, and frustrating those who bailed on the longs.

Figure 1. Corn Futures (ZC) 1 Hour Chart

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Whether the corn trade discussed on March 25 articles works out or not is anyone's guess. On a single trade anything can happen--it's only over many trades a statistical edge is revealed for a strategy.

The point is that false breakouts are a constant, not something you should just hope to avoid.

By knowing false breakouts occur a lot, you can change your thinking, and thus your results. Be patient. Allow false breakout to happen, and then when the price starts moving back in your expected direction, jump in. You just avoided a losing trade, and are now in a position to profit if your original expectations are correct.

Waiting for a false breakout to occur before entering may mean missing out on a few breakout trades (which didn't have a false breakout first). This is the trade off.

If false breakouts are a major problem for your strategy though (your strategy is losing money because of them) you have two choices:

  • Let a false breakout occur before you enter trade (at the time we don't know it will be false, so let the first breakout pass without trading it).
  • Or, change strategies so these false breakouts moves aren't stopping you out.

One other thing you can do is to only trade breakouts in one direction (based on analysis). In the corn example, I wanted the price to consolidate and then break higher. Therefore, shorting was never option in this price area. If the price would have broken higher first, the trade would have been taken. If your expectations about futures price movement are correct, you will often find the false breakout moves in the opposite direction of that expectation first.

The bottom line is: change how you think about a problem and what you do about it, and results will change. Some traders are capitalizing on false breakout (while others are losing). Don't get angry. Instead, strategize so you profit from the situation as well.

 

 

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