The 3 Step No-Hassle Breakout Strategy
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Talking Points:
- Volatility breeds breakout trading opportunities.
- 24-period Donchian Channel on an Hourly chart can give us medium term trade entries.
- Stops can be set opposite of the channel break using 1:2 risk and reward ratio.
While trend trading makes up the bread and butter of my personal trading account, I also employ a breakout strategy that has yielded positive results. It’s true that breakout strategies require more time and energy than longer term trend strategies, but breakouts are easy to trade when you have set rules to follow.
The ideal breakout trade is on a currency pair that has exhibited a high level of volatility and then breaks a key support or resistance level. Pairing this type of opportunity with a sound money management plan can result in a trading edge. Today, we are going to lay out this simple, no-hassle breakout strategy in 3 steps.
Step 1: Look for Volatility
Not all market conditions are ripe for breakout trading. We need to first find the pairs that have shown the most volatility. While you can independently figure out what pairs are the most volatile by ‘eye balling’ it, we prefer using DailyFX’s Technical Analysis page.
Learn Forex: DailyFX Technical Analysis - Volatility
(Copied from DailyFX.com’s Technical Analysis page)
The image above shows volatility highlighted in red. A 0% reading means a pair has shown almost no volatility while a reading of 100% means the pair has shown an extreme level of volatility. For the purposes of breakout trading, we recommend a reading of 75% or greater. So we need to make note of each pair with volatility above 75% before we move on to our charts.
Step 2: Find Trade Entries Using Donchian (Price) Channels
Support and resistance levels are subjective and can vary from trader to trader. So to more clearly define our entry levels, we use Donchian Channels or Price Channels. If you have never downloaded and installed the Donchian Channel indicator from FXCM Apps, you can download it for FREE by clicking here.
Once installed, you will find the Donchian Channel on your indicator list. The following are what settings we will use for spotting entries on an Hourly (H1) chart.
Learn Forex: Donchian Channel Settings
(Created using Marketscope 2.0 Charting Platform)
Once applied, we will see two blue lines on our chart, one above the price and one below. These lines will act as our trigger for placing a trade. If an hourly candle closes above the top blue line, we initiate a buy trade at market. If an hourly candle closes below the bottom line, we initiate a sell trade at market. Nice and simple.
Step 3: Easy Exits Using Stops and Limits
No strategy is complete without an exit strategy. Fortunately, the Donchian Channel can assist in setting one up. We first want to focus on our stop. I recommend setting our stop loss beyond the other side of the channel. So if the price broke below the bottom line and created a sell trade, we would set our stop a few pips above the top line. If price broke above the top line and created a buy trade, we would set our stop a few pips below the bottom line. The image below shows an example of a recent sell signal on the GBPUSD with a stop loss set above the top line.
Learn Forex: GBPUSD Breakout Trade
(Created using Marketscope 2.0 Charting Platform)
After we have set our stop above the upper channel line, we want to set our limit twice as far as our stop. So if our stop was 55 pips away from our entry, we would set our limit 110 pips away. The goal is to give us a 1:2 risk reward ratio which is an important piece of a winning strategy.
Give Me a Break
Trading breakouts doesn’t have to be hard. Once we know what rules to follow, everything falls into place. We want to find a volatile currency pair, witness a break of the 24-hour Donchian channel, and set a stop loss beyond the channel with a limit set twice as far. Feel free to email me with any questions you have.
Good trading!
---Written by Rob Pasche
To contact Rob, email [email protected].
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