What is false breakout? How to avoid false breakout?

If you are a trader then you should know the importance of breakouts and breakdowns. In that case if that breakout goes wrong and becomes a false breakout then it can cost a trader very high. So, due to that in the next 5–7 minutes we will study it completely and also will take your questions in the end.

Table of Contents :

• What is breakout
• What is false breakout
• How does it happen
• Why do false breakouts happen
• How to avoid it
• Points to remember

1. What is Breakout :-

Breakout is that action of an asset where it breaks the range formed by it with a resistance and a support level. To make it easy let’s understand by an example.

Suppose a stock has resistance at $200 and support at $180. When that stock will break this range of $180-$200 on any side then it will be known as breakout. Breakout basically means momentum in a consolidating asset after the movement from a particular range. You can see the breakout in the image given below.

2. What is a false breakout :-

In simple terms when the breakout fails, it is known as a false breakout. A false breakout is that type of breakout when an asset after breaking the range of support or resistance reverses, its direction and keeps itself in that direction. Let’s understand by an example.

Suppose in the above example the stock breaks the range on the upper side. After breaking $200 and goes up to $210. After that instead of keeping the momentum on the upper side it reverses back and goes below $200 and then keeps dipping. This is a false breakout. Let’s see in image below.

In the stock market when traders do trading whether its intraday or swing trading then they many times faces that. False breakout can lead to loss if you buy for breakout.

3. How does a false breakout happen :-

The false breakout happens when the stock does not remain in the direction in which it tends to be. Once the stock will break its support or resistance and then again reverse the direction and fail that breakout.

In some cases the price might see a throwback after a breakout. A throwback is when the price retraces back toward the resistance or support level just broken.

4. Why does a false breakout happen :-

(a). Volumes :

One of the many reasons for the false breakout is the volume of that particular security at the time of breakout. If the volumes of the stock or asset will be low at the time of breakout then chances of failure of that breakout will increase.

So, to identify the strong breakout we should focus on volumes. If volumes are high on breakout as compared to normal days volumes then chances of false breakout will reduce. This is also a part of Price action in trading.

(b). General Market Trend :

One more and important reason to find a false or genuine breakout is the Trend of the Market. You will see that if the market trend is upward then chances of sustaining the breakout are more on the upper side. Whereas if the market is downtrend then the upside breakout can fail.

As per history in the uptrend market 75%-80% breakouts sustain and only 20%-25% fail. Whereas in downtrend this data gets reversed. So, this is also the important aspect to find false breakouts or genuine breakouts.

(c). Candles :

Candles also help us to find the false or genuine breakout. If a stock breaks the resistance but till closing a long upper wick is formed then this is a indication that stock’s breakout may get failed because sellers are still there.

Whereas if on breakout a good green candle like Marubozu forms then chances of sustaining that breakout are more and trading can be done on that basis. To find false breakouts we should focus on the candle size and type.

5. How to avoid false breakouts :-

• The first way to avoid is to focus on volumes and only trade when the breakout is supported by volumes.
• Another method to avoid the false breakout in trading is General Market Trend. Always trade according to trend.
• If you focus on the size of candle and type of candle and trade according to that then also you can identify the false breakout.
• One more method to avoid the false breakout is trading on Breakout+Retest+Continuation, rather than straight breakout. It increases the probability of success.

6. Points to remember :-

(i). We should always keep in mind that if you take trade on the basis of breakout then if it becomes a false breakout then respect your Stop Loss and take exit from the trade.

(ii). To increase the probability of success try to trade in the Uptrend market and avoid trading in Neutral or Downtrend.

(iii). Don’t run behind breakouts blindly. Try to trade in the breakouts which are sustained.

Learn More :-

The information and names given above are just to enhance your learnings. These are not any kind of buy tips. Consult your financial advisor before investing. To keep learning and developing your knowledge of financial analysis, we highly recommend to read the additional resources below:

• Penny Stock
• High Growth Stocks
• Dividend Yield Stocks
• 5 best stocks for trading in June
• Fundamentally strong stocks

Thank You

Happy Investing