Breakout Trading Strategy: Identifying Breakouts

Intro

Highly effective for analyzing ranges and expecting trend reversals or continuations, the Breakout Strategy is one of those that sets the foundation for the trading journey of most crypto traders due to its simplicity. 

This strategy, like any other, can be highly effective, but it is not exempt from tricky signals. In this piece of writing, we will address key aspects to identify breakouts and understand how they work, remarking on the most effective patterns to consider when applying breakout strategies.

Understanding the Breakout Strategy

The concepts of support and resistance, along with those related to liquidity and stop-losses, let traders craft several variants of strategies to participate in the market. One of the most popular options, taking those concepts as the primary basis and highly profitable when properly practiced, is the Breakout Strategy.

This strategy, despite its simplicity, is remarkably efficient due to the forces it pursues regarding price movements in a crypto asset. Essentially, it is looking for sharp movements over a relevant area, such as support and resistance, waiting for the price to keep moving beyond that level.

The elements behind this strategy can be spotted in:

• Supply and demand.
• High liquidity levels.
• Shifts in the market sentiment.

Those elements in actions lead to the idea sustaining the breakout thesis: the price of an asset will continue its direction after breaking from a range. A range is where the liquidity is accumulated, conducting rapid price changes in a determined direction once it is broken.

How do breakouts work?

A breakout takes place in the markets when the price of a crypto asset gets ahead of a resistance or support level, and instead of weakening its path, it strengthens, indicating a shift in a trend or a continuation out from a range.

Breakouts might not just indicate a signal for a single trade but, in fact, a broader view of how investors and other traders are looking forward to a market moving in further times.

Types of breakouts

As you would expect from any strategy, breakouts can happen in either direction:

• Bullish breakout: When the price decisively overtakes a resistance area from a range. It can occur for two forecasts, for a potential upside trend continuation, or as a proposal for a reversal move.
• Bearish breakout: When the price overtakes a support area from a range. For a potential downtrend continuation or as a proposal for a reversal move.

Breaking Down The Breakout Strategy

Understanding deeply how the breakouts work is imperative to identify potential opportunities in the market, taking advantage of the best setups possible.

Breakouts might print significantly misleading signals as they are susceptible to sharp movements because of volatility conditions, resulting in false breakouts. Let's try to explain the core elements inducing breakouts in a crypto market.

Supply and demand

This is a core concept running the overall markets. In the context of breakouts, supply and demand will play a role in boosting the primary move, confirming the strength of the direction. 

Either one can emerge from the momentum sentiment generated by the rest of the participants, who would step into the market rapidly, trying not to miss the breakout move and increasing the speed in which the direction is reaching new levels of prices. Supply and demand can be measured by the volume indicator.

High liquidity levels

Similar to how supply and demand works, liquidity will impulse the direction of a breakout due to the subsequent dynamics of the trading flow. Liquidity can take action when the stop-loss orders are triggered, leading to fast changes in prices and increased volatility.

Something to be aware of in this case is that liquidity triggered by stop orders can cause a short momentum but not necessarily lead to a continuation as supply and demand would. In fact, a false breakout can emerge for the interests of ICT traders, for example.

Shifts in the market sentiment

As mentioned before, a breakout can also serve as a broader view of the market. An effective breakout can suggest the end of a trending season or its continuation. In either case, traders could analyze what investors are expecting, wondering if they are entering or exiting according to the direction the market is going.

Identifying Breakout In Crypto

As the crypto market bases its movements on a unique volatile characteristic, spotting breakouts can be easy but tricky. Developing a winning setup will lead to success with this strategy.

The following chart patterns are the most relevant for the case of breakout strategies. Let's take some notes.

Head and shoulders: breaking the neck for a reversal

The Head and Shoulders pattern forms a support line known as "the neck" which is, in essence, the area sustaining the pattern range. Breakout traders could jump into the market when that level is broken, potentially engaging in a trend reversal. Conversely, an inverted pattern will form a resistance neck, also susceptible to being broken.

Triangle: expecting a continuation

This pattern can be descendant or ascendant. It is a little range with dynamic support for the first case and resistance for the second, respectively. Those dynamic levels suggest a potential breakout continuation through the horizontal line in the direction of the triangle formation.

Range: sideways breakout

A range is a market condition in which the price goes repeatedly from support to resistance levels. The price is expected to break out from that range at any moment, taking over and being impulsed by all the underlying liquidity this market condition accumulates.

Range Breakout

Conclusion

Breakout trading is a simple and effective strategy that takes general concepts such as support and resistance as its basis, working through supply and demand and liquidity.

Breakouts can also offer insights into market sentiment. A decisive breaking movement towards a relevant level will suggest useful information on what traders could expect from upcoming market conditions.

Give this strategy a try by signing up for a free trial in Altrady and start paper trading Breakouts in crypto markets along with a wide range of technical indicators.