How to counter a fake price breakout

A currency movement fake-out, or a fake price breakout above or below a support or resistance level, is the bane of professional and amateur traders alike. They are just so hard to spot and difficult to remedy. The scenario usually goessomething like this: you’ve done your homework, you believe that the price is highly overvalued and think it should drop substantially, you’ve patiently waited for the price to fall below a long-held level for about 2 months, it finally does triggering your stop order… but then as if tripped up by a head fake on a basketball court, the price almost immediately pops right back up again taking your position way into the red.

Well, prevention is better than cure so the best strategy to avoid these situations is to wait until the price falls convincingly above or below a level. Never place an at-market order. Place a stop ‘buy’ or a stop ‘sell’ order to prevent yourself making impulsive trades, it’s important to remain disciplined.

The second strategy is (if for example, talking about a shorting order) to wait until the price settles at a level below the support and then put in a sell stop order below that. Often, the price or market will ‘think’ about the new price reality once a support or resistance level is broken and then continue its way down (or bounce back up if there is no further selling pressure). Place a sell-stop order a good 10 or 20 pips away from a support level, just in case it’s been miscalculated and placed incorrectly on the chart and even then, only allocate a small percentage of your equity to the position.Always assume there’s very good chance you’ve got it wrong.

Another important way to assess whether the break of a support or resistance level is genuine is to monitor appropriate technical indicators. For example, if there is divergence in an oscillator technical indicator signalling that there is upwards buying pressure, but the impervious pricefalls below a resistance line, it’s best to have your ducks lined up in row and hold fire. This approach is the same for fundamental analysis. If there is no real motivation for a price to fall below significant support (i.e. data release or geopolitical event), but it has been broken nonetheless, then again, it’s best to hold fire. If you have decided to enter a position, as mentioned, it’s best to wait until the price persuasively falls below a level. This means waiting until the next period (on the daily chart) or even the period after the next to confirm that the price is indeed following a new path.

If an order has already been triggered following a price spike down or up, stop losses are vital for cutting losses if the price rebounds in the opposite direction. If no stop loss has been added to the position, then a manual closing of the position is absolutely necessary. It will be difficult to accept the loss and to recognise the mistake, but a stop loss situated at the broken support or resistance level is the best policy. It’s best to recognise this fake-out problem as soon as possible as quickly retracing price behaviour can quickly become painful. Remember, every losing trade has a silver lining if you can learn from the error of judgement.

The below chart is an example of a GBP/USD misleading price breakout that lacks momentum to push higher. Notice the price falls in the period after the breakout.