Not always prices in the forex market move in one direction only. There are times when the price displays Bounce or Breakout symptoms, before the trend changes course.
At first glance, forex technical analysis is very complicated. Yet if you understand the key, anyone can do it. One of these keys includes being able to recognize Breakouts and Bounces. What are Bounces and Breakouts in forex? What are examples of Breakout and Bounce in forex?
Also read: Basics of Trading with Channels in Forex
The two terms will often appear to indicate the potential for the next move if the price movement approaches certain levels.
Any technical indicators used by traders, whatever trading methods are used, will definitely target the position of the price movement to Breakout or Bounce.
Because, Bounces and Breakouts in forex mark the emergence of trading opportunities with the best potential.
The Relation Of Breakout And Bounce With Trends
Before discussing the meaning of Bounce and Breakout in forex, we first need to know that the price movement in the market is not straight in one direction (up or down) forever.
At times, price movements will face a kind of “wall” that could potentially hinder the pace of the trend. However, some traders actually wait for the price to approach the ‘wall’ as a signal to execute the Market Order.
Technically, the ‘wall’ is referred to as Support or Resistance. Support is the lowest level on the price chart with a tendency to attract buyers because the price is considered too cheap.
Meanwhile, Resistance is the highest level on the price chart that tends to attract sellers, because the price is considered too expensive. Both terms are mandatory for traders to understand before understanding what Bounce and Breakout are in Forex.
Also read: What is Support Resistance in Forex Trading?
What are Breakouts in Forex
Breakout in Forex is the moment when the price moves through the Resistance or Support limit that has been created previously. Oftentimes, a breakout indicates a very large trend strength in maintaining its pace or forming a new trend.
The EUR/USD chart above shows how the price displays a breakout during a downtrend. If you look closely, the price was briefly corrected up (rebound), but eventually dropped again because the market is still controlled by the seller.
It should be noted, the main characteristic of the Breakout is that the price closes through the Support or Resistance limit.
In detail, the price must close higher than the Resistance limit or lower than the Support limit. If the price is unable to close at these conditions, it means that the Breakout has not or failed to occur.
The EUR/USD chart above exemplifies three types of possible Forex Breakouts. First, the Failed Break indicates the price’s attempt to break through the wall but failed to close as stated.
Next, even though the price has closed according to the Breakout rules, it turns out that the price has reversed direction (Fakey Break). Finally, the Breakout occurred as expected to continue the trend.
Also read: Understanding Time Frames in Forex
What is Bounce in Forex
Bounce in Forex is the moment when the price bounces after approaching the Support or Resistance limit. Contrary to Breakout, Bounce indicates a weak continuation of the current price trend.
The EUR/USD chart above shows price movements that are ‘confined’ within the upper limit of Resistance and the lower limit of Support during Sideways market conditions.
Observed, the upper axis of the candlestick shows the Seller’s resistance when the price approaches the Resistance limit, while the Buyer shows dominance when the candle shows the lower axis near the Support limit.
Bounces in Forex often occur when the price is still in a sideways condition, but the horizontal movement does not last forever.
If in the future there is a breakout that penetrates the Support zone, then the next price may experience a downtrend (Downtrend).
Meanwhile, if the Breakout penetrates the Resistance zone, then the next price may experience an uptrend (Uptrend).
How To Detect Bounces And Breakouts In Forex
Big profits can be obtained if the trader is able to predict when the Bounce or Breakout will occur. This ability is not based on mere speculation, but through systematic steps to map the direction of price movements. The steps:
- Identify the location of Support and Resistance.
- Determine the points where the price will bounce (Bounce) or break (Breakout) of known Support and Resistance.
From the basic examples above, Support and Resistance are determined by horizontal lines that are parallel to the lowest (low) or high (high) value on the price chart.
However, in practice, SR (Support and Resistance) can also be identified through other alternative methods. Two popular ways to do this are by making use of technical indicators and by monitoring the patterns of price movement itself.
Identification With the Help of Technical Indicators
Technical indicators can be a reliable choice for novice traders because they are relatively easy to use.
The measurements are relatively objective and can be used directly with standard settings (default settings). One of these technical indicators is Bollinger Bands (BB) which can be found easily on your trading platform.
In the EUR/USD chart image above, the Bollinger Bands (BB) indicator is an alternative to determine where the SR is.
Compared to the previous horizontal line, the BB line looks curved and uneven. Therefore, the BB line can also be called a dynamic SR line.
The orange circle highlights the occurrence of Bounces in Forex as long as the price is moving in Sideways conditions. Meanwhile, the red circle shows the Breakout as the end of a flat price condition and the beginning of a new trend.
Identification Through Positions And Price Formation
For experienced traders, they can find out the location of Support and Resistance based on the information displayed by the Candlestick chart (Price Action).
This method offers high flexibility at the expense of objectivity. That is, in this way, the location of the SR may vary between traders even though the currency pair and the timeframe of the chart are seen to be the same.
The descending triangle price pattern is formed on the EUR/USD (Daily) chart above. Notice how the Bounce in Forex occurs evenly at the Support level, but slowly decreases at the Resistance.
This formation indicates the weakening of the buyer’s strength so that when the price breaks out, the seller immediately takes action and makes the price fall freely.
In addition to the Triangle pattern, there are many other price patterns that can be used as a reference for forex trading. However, to recognize it, you first need to learn the ins and outs of Candlestick charts and price patterns (Chart Patterns).
Also read: What is Forex Market Sentiment?
Trading With Breakouts And Bounces
Knowing the basics of Bounce or Breakout in Forex is still not enough to practice forex trading, because we still need to know how to set the opening (open position/entry) and closing position (close position/exit) when the Bounce or Breakout occurs.
Every trader can actually make their own rules, but if you are new to the world of trading, then here is a general guide to help novice traders make entries and exits:
1. Define Entry Criteria
In a trading system, the trader establishes a reference or regulation of the conditions for opening a position. If all these conditions are met, then the position is opened, but if something deviates, the position is canceled.
These rules may vary between traders depending on experience and preferences of the trading system, but the general rule is: Watch where the last candle close is.
If the candle successfully closes above Resistance or below Support, it means that a breakout will occur. An example of the follow-up can be seen in Figure 6 which is based on the example of the Breakout on the chart with the BB indicator above.
Sample 6. Entry When Breakout From Resistance
The price seems to have a breakout because the candle successfully closed above the Resistance line and the upper line of the Bollinger Bands. That is, the price is expected to experience an upward trend.
You can choose to immediately open a Buy position, with the expectation that the price will immediately rise higher than the current price.
Alternatively, you can also place a Pending Order (Limit Entry Order or Stop Entry Order) if you want to enter at a different price from the current price.
2. Determine When the Trading Position Will Be Closed (Exit)
Trading positions should not be left open (floating) without a clear limit at what level the position will be closed.
You know price movements in the Forex market go up and down quickly. So, the longer a position is left running, the greater the risk as the trend rate can reverse without warning.
Generally, traders use the Risk/Reward ratio to determine profit targets and maximum loss limits. In the previous image, the position was opened with a Risk/Reward ratio of 1:2, or in other words, the profit target was twice as large as the loss limit. If the Stop Loss is placed 90 pips below the Entry (near the nearest Low), then the profit target is 180 pips.
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