Converging Breakout

Breakouts are classic trade setups that you'll find in any text book on technical analysis. Just because it's simple doesn't make it any less effective!



The price bars form a horizontal consolidation level and the expectation is that the price will break out of this level in the direction of trend continuation.

Here is the happy ending - a 180 pip move over a 5 hour period (against a stop loss of 22 pips). The red line is where I had a trailing stop so my actual gain was about 100 pips - significantly less than the full move, but I couldn't justify a tighter technically valid stop level.



Anyone who has traded breakouts knows that it's not always this simple. Here is a breakout that would have failed if traded:



Fortunately I anticipated that this breakout would fail, and placed a short term long position at the base of the spike in price that occurred at 22:30.

The approach I use to increase the chance of success on breakouts is based on what I have learnt from Nick McDonald. Prices can make sharp counter-directional moves due to snap-backs to moving average levels or negative divergence.

The first thing to check is that the break out is consistent with a trend continuation. This can be confirmed by looking at the overall trend on the current chart (15M) and the next time frame up (1H). All moving averages should be aligned and price should not be extended beyond the 10-20 MA zone. Next there should be no evidence of negative divergence. In fact, more strictly, the MACD and RSI indicators should display the same break out pattern as price.

There also needs to be the opportunity to set a very tight stop loss level that is still technically valid (i.e. defined by price action).

Finally here is another illustration of the convergence between price breakout and indicator breakout:



Notice in particular the convergence of the blue signal line on the MACD with price action. It's also worth pointing out that earlier in the day price was setting up for an upward breakout, but there was divergence with the indicators indicating either the breakout would not happen, or it if did then there would be a high possibility of it being a false breakout.