How to make the most of strong trends with breakouts

WITH trends picking up steam over the last couple of months, we have seen the return of an old and familiar trading strategy: breakouts.

The breakout was one of the first trading techniques I learned and it’s one of the easiest to understand. The idea is that the price trend of the asset we want to trade will remain in place. When the trend is bullish, we should buy when price breaks out above a prior major high. For short-term traders, a breakout above the prior session’s high is a common entry point. In the case of longer-term traders, they would look at major highs in the daily chart.

This strategy works well in strong trending markets. A good example is the Dax 30. Traders looking for a pullback to get a better entry waited in vain as it traded above 11,863 on Friday, and then reached 12,147 on Monday.

In the case of euro-dollar, price has been steadily trading lower since last year, and each time price declined to a new low the breakout trader would have sold euro-dollar. With euro-dollar’s unidirectional trend, this would have been a very profitable strategy. But very few people will act on such a strategy, as the fear of selling euro-dollar at the onset of a new low is strong. The only way to get rid of this fear is to act on it – doing it many times until we accept that it’s not such a bad strategy.

But before doing this, we need to know where to place a stop loss. In the case of a bullish trend, we would enter the market on a breakout above a prior high and place the stop loss at the level which invalidates the bullish trend.

Follow me on Twitter for daily ideas on how to trade breakouts @AlexFX00.

Alejandro Zambrano is a currency strategy analyst at DailyFX.com.