My top tip for avoiding fake breakouts
Someone on Twitter last night asked why someone wouldn’t short the first break of the trendline shown on the chart below of the SPY.
And today, I want to share with you what my answer to that question would be.
I’m going to keep this really simple….
What we are looking for here is volume, and specifically, changes in volume.
On the first break to the downside, there was hardly any bearish volume. However, on the second break which led to the eventual move down, there was 2x the average volume of the last 20 hourly periods (see the orange line that goes along the volume bars at the bottom).
Think of volume as interest in the market.
If there is no interest, why would the market all of a sudden change direction? The answer is it wouldn’t.
This is one method where you can avoid getting faked by false breakouts. If you look and the volume isn’t there, it’s usually a false break.
So that’s why I didn’t just jump in to a short trade after the break of the first trendline. I would waiting for confirmation that it wasn’t just a fake breakout – which we got with the second break.
This volume check can work very well in ranging markets, and can fit well with the information I gave you a few weeks ago about market makers & dealers (which you can read here.)
Let’s take another look another example. Here’s a EUR/USD chart from last week where I’d spotted a period of accumulation…
Note that as price approached the previous swing high, volume remained underneath the 20 period moving average.
If it were a valid breakout, volume would have been a lot higher.
Also note that after the stops were run on the previous swing high, the market fell off…
This is how the dealers ‘work’ a range. They run highs and lows and accumulate until the market moves in the direction of their positions.
Optimising a strategy using volume is a great way to increase your win rate and filter out trades that otherwise may have been either not taken or ended up as losers.
Have a go at it and let me know how you get on.