Channel breakout forex

A 3 Step Trading Plan for Channel Breakouts.

by Walker England.

First find the trend to determine the trend Learn to enter Forex breakouts using Donchian Channels. Channels can be used to trail your stop and lock in profit.

The Forex market is known for its strong trends, which can make trading breakouts of support and resistance levels an effective approach to the markets. To plan for such market conditions , today we will review a three step breakout strategy using the Donchian Channels.

Let’s get started!

The first step to trend trading is to find the trend! There are many ways to identify the trends depicted below, but one of easiest is through the use of the 200 period MVA (Moving Average). To begin add this indicator to your chart, and then see if price is above or below the average. This is how we will determine the trend and our trading bias.

Given the information above, traders should look for opportunities to buy the EURJPY in its current uptrend as price is above the average. As well, the AUDNZD pictured below offers selling opportunities since the pair is priced under the 200 period MVA. Once we have this information, then we can plan entry placements for a potential breakout.

Learn Forex – Daily Charts & 200 MVA.

(Created using FXCM’s Marketscope 2.0 charts)

Trading Donchian Channels.

Donchian Channels are a technical tool that can be applied to any chart. They are used to pinpoint current levels of support and resistance by identifying the high and low price on a graph, over the selected number of periods. For today’s strategy we will be using 20 periods meaning that the channels will be used to identify the 20 day high and low in price.

Since the price of the EURJPY is trading above the 200 MVA, traders will want to identify new entries to buy the pair on a breakout towards higher highs. With our current 20 Day high identified by the Donchian Channels at 145.68 traders can set an entry to buy the EURJPY one pip above this value.

Now, let’s look at how to enter into a sell position.

Learn Forex – EURJPY Daily with Channels.

(Created using FXCM’s Marketscope 2.0 charts)

The process of initiating sell positions in a downtrend is exactly the opposite. Again, we will revisit the AUD/NZD Daily graph pictured below. As price is below the 200 MVA, traders will look to sell the pair in the event of price creating a new 20 Day low. Currently that low resides at .8775 and traders can look to initiate new sell positions under that value.

Learn Forex – AUDNZD Daily with Channels.

(Created using FXCM’s Marketscope 2.0 charts)

Setting Risk & Trailing Stops.

When trading any strategy, setting stops and managing risk should be considered. When using Donchian Channels, this process can be simplified. Remember how our pricing channels (representing the 20 Day high or low), act as an area of support or resistance? In an uptrend, price is expected to move to higher highs and stay above this value. If price moves through the bottom channel, representing a new 20 Day low, traders will want to exit any long positions. Conversely in a downtrend, traders will want to place stops orders at the current 20 period high. This way, traders will exit any short positions upon the creation of a new high.

Traders may also use the Donchian Channels as a mechanism to trail their stop. As the trend continues, traders may move their stop along with the designated channel. Trailing a stop in this manner will allow you to update the stop with the position, and lock in profit as the trend continues.

---Written by Walker England, Trading Instructor.

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Forex Mini-Channel Breakout Day Trading Strategy.

Getting You Into Big Trending Moves.

I designed the forex mini-channel breakout strategy to get me into trending moves when very specific conditions materialize. The day trading strategy relies on strong momentum, a trend and a specific type of pullback to create a trade setup. The setup sometimes occurs multiple times a day for weeks on end, and other times a signal may not occur for several days. The strategy requires volatility, so only use it when volatility is high.

When volatility is low, using another forex day trading strategy.

Forex Mini-Channel Breakout Setup.

Strategies require a setup. The setup is the conditions that need to be present in order to take a trade.

The forex mini-channel breakout strategy requires a strong trending move, either up or down, followed by a tight channel moving in the opposite direction of the strong trending move. For example, a sharp rally higher, followed by a move lower that oscillates between descending trendlines (forming a channel).

The move prior to the channel must be strong. For forex day trading purposes, the price should run at least 12 pips in the trending direction. The pullback that follows should fit neatly within trendlines, and the trendlines should be relatively tight together, especially the longer the trend channel lasts.

Ideally, the channel should be 5 pips wide, or narrower. The price should not make "waves" inside the channel (makes channel too wide), rather it should oscillate very tightly within the trendlines.

The pullback (channel) can't retrace more than 65% of the prior trending move. For example, if the price jumps 20 pips to 1.0520, the declining channel that follows can't drop more than 13 pips (65% of 20 pips) from 1.0520.

If it falls below 1.0507, don't use this strategy.

We want to be on the same side (trade direction) as the traders who are more aggressive. The pullback (channel) is smaller than the initial trending move (65% or less), showing buyers are still in control despite the short-term drop in price.

The small channel means our risk is small relative to our profit potential. This is discussed next.

Forex Mini-Channel Breakout Strategy.

Draw trendlines along the channeling price, and make sure the price is contained within the channel (not jumping above or below the trendlines).

If the trend is up, followed by a declining channel, enter long when the price breaks above the channel. Place a stop loss below the most recent low in the channel. Place a target at 3 times your risk. Your risk is the difference between entry point and stop loss.

If the trend is down, followed by a rising channel, enter short when the price breaks below the channel. Place a stop loss above the most recent high in the channel. Place a target at 3 times your risk.

By only trading very small channels--5 pips or so--the distance between your stop loss and entry point is small. only about 5 pips. This is your risk. The target is three times that amount, or 15 pips in this case.

Your target (in pips) should always be less than the size of the prior trending move. If you calculate your risk, multiply it by three, and the result is a larger number than how far the price ran on the last trending move, skip the trade. In this case, the trending move prior to the pullback (channel) should ideally be 20 pips or larger.

The attached chart shows an example of the mini-channel breakout strategy in the EURUSD. The price runs higher, forms a small 3 pip channel (distance between trendlines), and triggers a trade before pulling back too far. Risk is 3 pips, so the target is 9 pips. The target is smaller than the prior up wave (14.2 pips) that started the uptrend, so this is a reasonable target and the trade is taken.

Tying it Together.

Assume the price falls 25 pips in a matter of minutes, reaching 1.0620, and the trend is down.

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The price starts to pullback in a tight channel. Draw trendlines on the channel, and watch for the price to drop below the channel. Only take the trade if the signal occurs before the price reaches 1.06362 (65% of 25 pips, added to 1.0620). While the channel is forming, make sure your risk is small (tight channel), and that you know exactly where your stop loss and target will go if the trade signal occurs. If the channel is about 6 pips wide, have a stop loss ready to be placed 6 pips above your entry point, and a target 18 pips below your entry point.

This trade requires very specific conditions, and the reason is that if you don't adhere to the guidelines it's easy to lose money with this strategy. The main reason is that the price may move slightly outside the channel, only to move back into it and continue channeling (false breakout--a strategy on its own).

Therefore, look for strong movement followed by tight channels. When strong momentum is present that momentum is likely to spark interest as soon as the price shows any intention (breakout) of moving in the trending direction again.

Don't force this strategy. Have it in your trading tool belt for days and weeks when it appears often, but don't try to trade it on the days and weeks when conditions aren't suited for it.

The Retest Breakout Trading System.

Many breakout traders also use opportunities when the price breaks-out of any type of trading pattern. This can be a triangle, a head-and-shoulders pattern, a flag, a box channel as well as the more common support and resistance levels.

This type of style seems counter-intuitive to a fundamental trader. A fundamentalist’s goal is to buy below fair value, and sell above. The idea of buying as the price makes new highs, or selling as it reaches new lows, as breakout trading does, goes against this viewpoint. Despite this, technicals are influential in the near-term and breakout strategies that exploit them can be highly profitable.

The appeal of breakout trading is clear It is easy to grasp and is a quick win strategy that can lead to high profits. The largest profits in any market usually lie in the first few bars of a newly forming trend – this is where the strongest price acceleration is. Explosive breakouts often take place after volatility squeezes (see below). The breakout trader aims to be in at the beginning of these powerful trends.

Breakout events are extremely common in Forex charts . They also occur across different time frames. Nevertheless, having a good grasp of technical analysis is necessary to identify which of these are worth trading and which are best avoided. Technical indicators allow the breakout trader to judge how robust a given channel is and if a break attempt is likely to be successful or not.

Most breakout traders use a combination of other inputs to form their decision. However, in the end, it often comes down to experience and gut instinct. The occurrence of false breaks also makes timing decisions difficult.

How to Avoid False Breaks.

Those who try this strategy soon learn that false breaks are its “Achilles’ Heel”. According to most estimates, at least fifty percent of Forex chart breakouts are “false breaks” or “fake outs”. With a false break, the price breaks out of a range temporarily, only to pull back again shortly afterwards.

This is frustrating to the breakout trader, and several runs in succession can wipe out hard won profits. Even more maddening is when you exit the breakout trade on a retracement, only for the price to double back again in the breakout direction. These kinds of retracements are what thwart the breakout traders strategy.

Wait for the retest To counter these situations some breakout traders wait for the previous level to retest before entering the trade. They wait until the price reverses and retests the boundary at least once. They then only enter the trade if the retest succeeds ( or fails if you are a range trader ), and the price bounces back. This is shown in Figure 2.

A successful re-test on the downside suggests the previous resistance has become a new support. Conversely, a successful re-test on the upside suggests the previous support has become a new resistance. Stop losses are placed so that the position is closed if the price moves through the boundary, back into the range a second time. This is not a guarantee. It does though increase the odds of catching real breaks rather than a fake.

This is because the second move suggests there is genuine momentum driven by real supply or demand. Using it means the trader enters breaks that have a higher probability of success. On the downside, it does mean capturing less of the move because of the delay on commitment to trade.

It is always good practice to check key support and resistance levels by looking at the chart in several time frames. Fibonacci extensions/retracement can help in deciding your entry and exit points after these key levels are identified. Using additional signals that confirm direction at a support/resistance also provide an advantage.

Why Are “False Breaks” So Common?

There are two reasons why false breaks happen so often.

Range traders Firstly, there are more range traders than there are breakout traders. These traders believe that the most likely course is that the price remains within the established range. Range traders see the break as an anomaly . They need to see a significant break from an established channel before they will consider it permanently breached. Given this, range traders are likely to trade against the breakout. They become faders .

Dealers The second reason is dealer manipulation. Dealers may look to stir-up a quiet market and stimulate volatility. A dealer can estimate from order flow, that there probably is not enough interest to break out of a range. Even so, they may test weaknesses in the trading channel by pushing their quote.

They do this especially when they’re axed , or have a need to trade in a certain direction to reduce their net position. This may cause some breakout traders to enter prematurely.

As a result, other breakout traders may do the same as they see a newly forming trend, which will build momentum. More often than not though there is no real follow up. The gap closes and the price re-enters the range trapping those caught on the wrong side.

Range traders also tend to trade against these types of moves, which adds to the strength of price pullback into the original channel.

Given the high failure rate of breaks, some traders believe it more profitable to trade against these events. That is, to trade in the opposite direction to the breakout move. This is called fading . There are some who say that most faders are converted breakout traders who have given up and resorted to reversing their strategy. Caught out too many times by false breaks, these traders believe the reverse strategy to be the more profitable one.

Using Volume Indicators.

People often say that the main drawback with breakout trading in Forex markets is that there are no reliable real-time volume indicators . In my view this issue is a bit overblown. If you have ever traded “on exchange” products, you might have seen the flow of orders, which is sometimes made available for traders to see as part of the exchanges’ commitment to transparency.

This allows you to watch in real-time the orders flowing through the exchange. From the order flow, a trader can determine the supply and demand and watch for any liquidity gaps. A gap in liquidity can cause high volatility without a clear price direction.

This is a major problem for breakout traders because liquidity gaps are where many failed breaks occur. However this mostly happens when trading relatively illiquid markets such equities.

Knowing the variations in daily trading volume will help you to avoid false breaks on predictable light volume and session handovers.

When trading most major currency pairs, the kinds of liquidity gaps which you see with equities for example, just don’t happen. In Forex there are always periods of light and heavy order flows as the major markets open and close. However volume is relative.

For example, EUR/USD puts through around $1 billion dollars notional volume per minute on an average day, whereas even EUR/JPY puts through around $100 million per minute.

Momentum trades The main challenge of the Forex breakout trader is to identify if a break has momentum behind it, or if it is just dealers pushing the quote around to try to stimulate activity. Some brokers will provide their own volume data as part of a market data feed. If so, this can be valuable input. There are also proxy volume indicators, such as on MetaTrader that can be useful.

Keep in mind the time of day and the pair you are trading. Familiarize yourself with the regular daily fluctuations in volatility. Regular variations happen because of the opening, closing and overlap of the regional trading sessions. Knowing these variations will help you to avoid false breaks on predictable light volume and session handovers.

Use Staggered Entries.

Using multiple trade entries is always good practice with this style. When trading breakouts it is especially important due to the high probability of price reversals. A system of staggered entries, also called a grid system can work in your favor.

With a grid, you can create your orders in such a way that you divide your risk over a number of smaller trades. This is safer than committing to one big all-or-nothing trade. With this strategy, you build up the position as you gain more confidence in the reliability of the breakout. This is shown in Figure 3.

With a grid, depending on your chosen setup, you can also profit either from a straight through move, or from a whipsaw-move, that crosses all levels.

A grid also helps to enforce your trade management, making it less subjective by presetting appropriate stops and take profits. A separate article on Forexop covers grid trading in more detail (see here).

Volatility Squeezes.

If you look at volatility data for any market over a period, you will notice it often runs in cycles. High volatility phases often come after periods of low and declining volatility. A narrowing of the Bollinger bandwidth identifies these events easily. Due to this, the Bollinger bandwidth is an important technical input to this strategy especially when automated.

Bollinger squeezes or volatility squeezes often happen just before powerful breakout events. This is why it is important to know them and identify them. They can provide you with the most profitable breakout trades.

A lowering of volatility causes a contraction of the bandwidth. The chart above shows type of event. Squeezes often happen prior to news releases and announcements. They can also happen during trading session handovers. This is because traders in the open session pause to assess the sentiment of the major markets such as London or New York as they come into play.

False breaks do still happen here. These are especially common after important news events. A separate article on trading economic news explains the reasons for this.

How to Use Breakout Trading.

Breakouts occur when the market moves rapidly in a single direction. They happen at all time frames. They often appear after volatility squeezes – so identifying these events is important. News releases or the collapse of a technical pattern can be the trigger. Use a system of multiple, smaller trades and build the position as confidence in the breakout is established. Or use a straddle strategy. Check the price action preceding the trading range to establish likely new support or resistance levels. Use the “retest method” to reduce entries into false breaks, and trade longer time frames to avoid “market noise”.

If you want to try breakout trading, the following resources may be of help:

Want to stay up to date?

A rising window is usually found in bullish surges where the price is rising quickly. The pattern represents. Trading the Falling Window Signal.

A falling window is a type of candlestick pattern that can appear in market selloffs. It forms where. Marubozu Candlestick Patterns and What They Mean.

The marubozu certainly can be a useful trading signal owing to its simplicity and its easy interpretation. The Bearish Breakaway.

A bearish breakaway is a chart formation that can appear in a rising market when the price starts to. The Bullish Breakaway.

A bullish breakaway is a chart reversal pattern that can appear in either a bullish or bearish market. Bullish Trend Reversals – The Tweezer Bottom Chart.

A tweezer bottom is rather weak bullish reversal signal. But it can be useful when used alongside other. Three White Soldiers Chart Pattern.

Three white soldiers is a candlestick chart pattern that’s normally associated with a bullish reversal.

I’m looking to get my Forex Breakout Direction Indicator listed on your site.

Thanks for the excellent article. I learned a lot about Breakout trading.

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Strategies.

Steve Connell has spent over 17 years working in the finance sector as a trader/market maker and strategist. Over that time he’s worked for several global banks and hedge funds. Steve has a unique insight into a range of financial markets from foreign exchange, commodities to options and futures.

ATR Channel Breakout Trading System.

You will find further below the rules and explanations for the ATR Channel Breakout trading system. It is a classic trend following system, available in the public domain.

ATR Channel Breakout Trading System in the Wisdom State of Trend Following.

Using several classic trend following systems , like the ATR Channel Breakout Trading System, we publish the Wisdom State of Trend Following report on a monthly basis. The report was built to reflect and track the generic performance of trend following as a trading strategy.

The composite index is made up of a mix of systems simulated over multiple timeframes and a portfolio of futures, selected from the range of 300+ futures markets over 30+ exchanges that Wisdom Trading can provide clients access to. The portfolio is global, diversified and balanced over the main sectors.

We publish updates to the report every month.

Subscribing is the best way to keep track and follow the performance of trend following on a regular basis.

The ATR Channel Breakout System Explained.

The ATR Channel Breakout Trading System is a variation on the Bollinger Breakout System which uses Average True Range instead of standard deviation as a measure of the volatility which defines the width of the channels or bands.

A variation of the ATR Channel Breakout System was popularized as the PGO system by trader Mark Johnson on Chuck LeBeau’s System Trader’s Club forum and elsewhere. This version, the ATR Channel Breakout Trading System, is more flexible and permits the testing of different entry and exit thresholds.

The ATR Channel Breakout system is a form of breakout system that buys on the next open when the price closes above the top of the ATR Channel, and exits when the price closes back inside the channel. Short entries are the mirror opposite with selling taking place when the price closes below the bottom of the ATR Channel.

The ATR Channel Breakout trading system trades based on a volatility-band breakout where volatility is measured using Average True Range (ATR). The center of the ATR Channel is defined by an Exponential Moving Average of the closing prices using a number of days defined by the parameter Close Average Days. The top and bottom of the ATR Channel are defined using a fixed-multiple of ATR from the moving average specified by the parameter Entry Threshold.

The ATR Channel Breakout trading system enters at the open following a day that closes over the top of the ATR Channel or below the bottom of the ATR Channel. The system exits following a close below the Exit Channel which is defined using a fixed-multiple of ATR from the moving average specified by the parameter Exit Threshold.

This ATR Channel Breakout trading system is similar to the Bollinger Breakout Trading System except that it uses Average True Range instead of standard deviation as a measure of the volatility which defines the width of the channel.

For example, an Entry Threshold of 3 and an Exit Threshold of 1 would cause the system to enter the market when the price closed more than 3 ATR above the moving average and to exit when the price subsequently dropped below 1 ATR above the moving average. NOTE: Exit Threshold can be a negative number which will cause the system to exit only after the price comes some amount through the moving average.

The ATR Channel Breakout trading system includes four parameters which affect the entries:

The number of days in the Exponential Moving Average for the Average True Range itself.

The number of days in the Exponential Moving Average of daily closes which forms the center of the ATR channel.

The width of the channel in ATR. This defines both the top and bottom of the channel. The system buys or sells to initiate a new position when the closing price crosses the price defined by this threshold.

If set to zero, the system will exit when the price closes below the moving average. If set to some higher number the system will exit when the price closes below the given threshold. A negative Exit Threshold means that the exit channel is below the moving average for a long position.

Your Custom Version of this System.

We can provide you with a customized version of this system to suit your trading objectives. Portfolio selection/ diversification, timeframe, starting capital… We can adjust and test any parameter to your requirements.

Contact us to discuss and/or request a full custom simulation report.

Alternative Systems.

In addition to the public trading systems, we offer to our clients several proprietary trading systems, with strategies ranging from long-term trend following to short-term mean-reversion. We also provide full execution services for a fully automated strategy trading solution.

Please click on the picture below to see our trading systems performance.

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Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

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