Tuesday, July 14, 2009

Catching False Breakouts

A false breakout occurs when we get new highs or lows following an extended trading range, only to see trade return to that range. These occur at every time frame: we had a false break last week in ES that took us below the May/June lows, only to see us vault back into the range. We had a shorter-term false break to the downside this morning (above Market Delta chart), when ES made new lows for the AM. As the intraday Twitter comment pointed out, that low was not confirmed by fresh lows for the NASDAQ or Russell averages--often a nice tell for false breaks.

The reason these are great setups to trade is that they enable you to profit from the frantic covering of positions among traders counting on a true breakout and trending move. As the chart above illustrates, a fade back into the day's range is generally a great play for a move back to the VWAP. On sustained strength, those false breaks lead to a complete rotation through the range to the opposite extreme.

Here's a post that offers further guidance on catching false breakouts. I'll have more to say on this topic in Friday's seminar.