Breakouts and trading
As the name suggests, a breakout is when the price breaks out of a consolidation or trading range. It can also be about a happening that involves a price level like support or resistance, pivot point, Fibonacci, and the like is breached. Trading these is more of a correct entry as the price breaks out, then continue to hang along with this trade until there is no more volatility.
Volatility and forex trading
We can say that forex trading is unlike any other because of a lot of things. We can include in that list is the fact that it is almost impossible, if not impossible, to know the trading volume. This also means that we have a lesser chance to trade breakouts successfully. But at least, we know some things about them:
- Massive price movement and a short time frame = high volatility
- Significantly less price movement and a short time frame= low volatility
Keep in mind that high volatility is somehow like a trap to most traders. It is attractive to enter a market when it is too volatile, but it might also lead you to terrible decisions and make your money fly out the window. We must know how to use the volatility in your favor. As tempting it might be to join the bandwagon in a volatile market, it might also be a great idea to enter trades with currency pair that has low volatility. You will have time to get ready for a breakout and high volatility.
How vital is volatility when trading breakouts?
Volatility helps a trader pinpoint great breakout opportunities by acting as a measuring tool for price fluctuations in a time frame. Unlike trading volume, there are ways to measure the pair’s volatility at the moment. There are some indicators for that, and they can be helpful when looking for breakout opportunities. Let us start!
One of three: moving averages
Moving average is simple, and maybe that is why many people prefer and love using it. Albeit its simplicity, it offers great help as it measures the market’s average movement for x amount of time. You can place x anywhere you prefer.
Two of three: Bollinger bands
Bollinger band’s sole purpose is volatility measurement. They are two lines plotted with two standard deviations on top and under a moving average for x period. You can place x wherever you prefer. For instance, we set 20; then we have a 20 SMA and two other lines.
Then, we will plot another line +2 standard deviation on top of it and -2 standard deviations below for the other line. Remember:
- Contracting bands = low volatility
- Wide bands = high volatility
Three of three: average true range
ATR lets us know the market’s average trading range for x period. You can place x wherever you prefer. In short, ATR is taking the currency pair’s range. This range is the distance between time frame understudy’s high and low. Next is plotting the measurement as the moving average. For instance, setting the ATR 20 on a daily chart will show you the past 20 days’ average trading range. Remember:
- Falling ATR= declining volatility
- Rising ATR= increasing volatility
However, ATR can only tell us so much like the volatility but not the direction.
Capping off this 2-in1 lesson
We want to enter the market at the right time, like when there is a price breakout to ride that trade until there is no more volatility. And when we say volatility, we are talking about something that serves as a measurement of price changes in a given period that can help detect breakouts.