Day trading is the practice of buying and selling stocks within the same trading day or even multiple times over the course of a day. Taking advantage of small price moves can be a successful ploy if done correctly. Yet, it can be dangerous for beginners and brokers who are not suited for higher volumes of trades generated in day trading.
Most novice traders share one fear: false breakouts. A stock is usually anticipated to move in a certain direction, but before you know it, the price rebounds, putting traders in a losing position. It is frustrating and can cost you heavily. Your next step should be to change your attitude to be positive and capitalize on every false breakout that you encounter. Here’s how.
Not Every Breakout Is False
False breakouts are a part of day trading. They occur all the time. But there is a way to work around false breakouts. They are best traded in the direction of the trend. Suppose a pattern is developing in the trend, and the price breaks below the trend only to jump back up.
The trend here dictates that the price is likely to move higher, and this is a trade you want to buy into. A false breakout on the downside adds to this supposition that if it has hit rock bottom, it will definitely try to go higher.
Also, in order to get the best returns, make sure that you are using the right day trading setups for profitable trading.
Use Your Psychology
Often, at the beginning of your trading career, one of the first strategies you learn or want to learn is a breakout strategy. The idea behind a breakout strategy is to capture a huge move following an easy-to-spot pattern. You have to train yourself to be vigilant and psychologically strong. Trading breakouts can work, but you have to be aware of any false breakouts where the price breaks out of the pattern only to revert back in.
These happen as a result of the “herd mentality” that causes people to buy the top of a move and sell the bottom. Try to read between the lines when feeling the frustration caused by false breakouts. If you are losing money, someone out there has to be making money. So can you, as long as you practice, focus, and hone your reflexes.
The Strategy
The strategy is easy and simple. When false breakouts happen, they will try to suck you into trading the breakout. You don’t have to give in. Be calm and strategize everything. Only trade in the direction of the trend. Think about what would create a false breakout in the opposite direction of the trend. What would be your course of action if it does happen?
What would you put your stop loss on, and what would be the point where you could get out still making a profitable trade? Address these points as the trade is being set up. If you do take the call and make the trade, you can go right ahead. This strategy should be memorized and ready for every time a trade develops.
Final Considerations
The market being traded and the context of the trade will determine how far the price moves back into the pattern for it to be considered a false breakout. On a volatile day, the amount the price needs to move back into the pattern will be more than on a day when the volatility is low.
The quickness and depth of the breakout need to be assessed for it to be termed as false. A false breakout should be relatively small and short-lived for trading purposes. Don’t get tempted by the target. Exit immediately if a false breakout occurs in the direction opposite to that of your trade. You will still trade normal breakouts in the direction of the trend, which is more likely to work out in your favor.