The ‘False Break’ Trading Strategy

 
 

When was the last time you entered a trade and it immediately moved against you even though you felt confident the market was going to move in your favor? When was the last time you traded a breakout and got stopped out? I’m willing to bet you’ve experienced one or both of these things recently in your own trading, and I’m also willing to bet that me or one of my students probably took the opposite side of one of these trades that seemed to ‘fake you out’ of your position…
You see, false-breaks happen all the time in the markets; they are a result of the ‘herd mentality’ that causes people to buy the top of a move or sell the bottom. As price action traders, we are in a unique position to take advantage of false-breaks and of the weak ‘herd mentality’ that so many amateur traders possess.
I have made most of my money as a trader by using contrarian trading approaches like false-breaks and my proprietary fakey trading strategy. It is the power of contrarian trading and using false-break patterns and fakey setups that allows myself and other savvy price action traders to profit from other traders’ misfortunes. This may sound a little harsh, but it’s the reality of trading that the majority of traders lose money, informed and skilled traders make money, and the ‘pigs get slaughtered’, as the saying goes. I hope there are light bulbs going off in your head now, because this article is all about contrarian thinking, false-breaks, and how to take advantage of the ‘herd mentality’ that causes so many traders to enter right when the market is about to change direction…

So what exactly is a false-break?

I thought you’d never ask! Joking, I know you are probably thinking that right now, so here you go…
A false-break can be defined as a ‘deception’ by the market; a test of a level that results in a break of that level but the market then retracts and does not sustain itself above or below that level. In other words, the market does not close outside of the level being tested; rather it leaves behind a false-break of it. These false-breaks are huge pieces of evidence for impending market direction, and we need to learn to use them to our advantage instead of becoming their victim.
Here is a visual example of a false-break of a key market level:
Essentially, a false-break can be thought of as a contrarian move that ‘sucks’ the over-committed side of the market out. The concept is to wait for the price movement to clearly show that a market has committed to one side of a trade and that they would be ‘forced’ to liquidate their position(s) on a strong reversal in the other direction. Typically, we see these scenarios unfold as a trending market becomes extended and all the amateurs jump in right before the counter-trend retrace, or at key support and resistance levels or at consolidation breakout scenarios.
The herd mentality causes traders to enter the market typically only when it ‘feels’ safe. However, this is the deception; trading off feeling and emotion is exactly why most traders lose money in the markets. Many traders become deceived because the market looks very strong or very weak, so they think it’s a no-brainer to just jump in with that momentum. However, the truth of the matter is that markets ebb and flow and they never move in a straight line for very long. This is known as “reversion to the mean” and it’s something I expand on significantly in my advanced Forex trading course.
We really have to use logic and counter-intuitive or ‘contrarian’ thinking to profit off of the weak-minded herd mentality that dominates most traders’ minds. This is why it’s very important to remain disciplined in the area of trading false-breaks, rejections and failures, and why I love trading them so much.

Types of False Breaks

1. Classic Bull and Bear traps at key market levels
A bull or bar trap is typically a 1 to 4 bar pattern that is defined by a false-break of a key market level. These false-breaks occur after large directional moves and as a market approaches a key level. Most traders tend to think a level will break just because a market has approached it aggressively, they then buy or sell the breakout and then many times the market will ‘fake them out’ and form a bull or bear trap.
A bull trap forms after a move higher, the amateurs who were on the sidelines watching a recent strong move unfold cannot take the temptation anymore, and they jump in just above or at a key resistance level since they feel confident the market now has the momentum to break above it. The market then breaks slightly above the level and fills all breakout orders, and then falls lower as the big boys come in and push the market lower, leaving the amateurs ‘trapped’ in a losing long position.


2. False-break of consolidation
False breaks of consolidation or trading ranges are very common. It’s easy to fall into the trap of thinking a trading range is going to breakout, only to see it reverse back into the body of the range. The best way to avoid this trap is to simply wait until there is a clear close outside of the trading range on the daily chart, and then you can begin to look for price action trading signals in the direction of the breakout.

Success in Forex = Learning + Practicing + Update Knowledge

Set and Forget Forex Trading 2

Less is more in Forex: ‘Set it and Forget it’

So how does the aspiring trader achieve consistent profitability trading the Forex market if we are genetically primed to over-complicate it? The very first step in this process is just accepting the fact that you cannot control the uncontrollable Forex market and checking your ego at the door. The Forex market does not care what you have done in your life before; it has no emotion and is not a living entity. It is an arena where human beings act out their beliefs about the exchange rate of a certain currency pair. These beliefs are a result of emotions, and human emotion is very predictable when it comes to money. The point here is that the people mentioned in the previous section who are doing extensive amounts of research and trying to find the “holy grail” trading system are the ones who are trying to control the market and thus trading based off emotion. These people are providing the predictability for the professionals to take advantage of.
The paradox here is that professional traders may actually do less technical and fundamental “homework” than amateur / struggling traders; pro traders have mastered their trading strategy and they simply stick to their daily trading routine and see if their edge is there. If there edge is not present, then they just walk away for a while because they know that the Forex market is a continuous stream of self-generating opportunities, thus they do not feel pressured or anxious to trade. If their edge does show up then they set their orders and walk away, accepting the fact that any further action will probably work against them because it will be a vain attempt to control the uncontrollable and would not be an objective action.
The logic of set and forget forex trading is this; if your trading edge is present then you execute your edge and do not involve yourself further in the process unless you have a valid price action-based reason to do so. Traders that decide to mess with or tweak their trade once they enter it almost always kick start an emotional roller coaster that leads to over-trading, increasing position size, moving their stop loss further from their entry, or moving their profit target further out for no logical reason. These actions almost always cause the trader to lose money because they were not objectively thought out, but were instead influenced by an emotional reaction that was caused by trying to control the uncontrollable.
In the chart below, we see an example of how many traders get into trouble by being too involved with their trades. As the market retraced back toward the entry point of the pin bar sell signal, emotional traders would have probably exited for a very small profit or near breakeven because they felt “scared” or “nervous” that they might lose money on the trade.
In the chart below, we can see that just as the market got to about the low of the pin bar sell signal where most traders would have entered, it stalled and then fell significantly lower back in-line with the downtrend. Disciplined traders who do not “meddle” in their trades for no reason would probably have still been short and would have clearly made a very nice gain. Note how a traders could have waited for an opposing obvious price action buy signal to exit the trade…this is exiting on logic and price action rather than emotions like fear or greed.

Make Money and Save Time by Doing…Less?

It is a well-studied fact that traders who trade off higher time frames such as 4 hour, daily, and weekly charts and hold their positions for multiple days, make more money in the long run that traders who “day trade” off intra-day charts. The reason many people are attracted to day trading is because they feel more in control of the market by looking at smaller time frames and jumping in and out of positions frequently. Unfortunately for them, they have not figured out that they have the same amount of control as the swing trader who holds positions for a week or more and only looks at the market for twenty minutes a day or even less. That is to say, neither trader has any control over the market, but day-trading and scalping gives traders the illusion of more control. The only thing we really have control over in trading, is ourselves.
The ironic fact about Forex trading is that spending less time analyzing data and finding the “perfect trading system” will actually cause you to make more money faster because you will be more relaxed, less emotional, and thus less likely to over-trade or over-leverage your trading account. Many people are attracted to speculative trading because they want a way to make money that is “less difficult” than their current job, but they soon forget about that and start spending countless hours digging themselves into a huge psychological trap that most of them never dig out of. All you basically need to do to consistently make money in Forex is master an effecting trading method, develop a written out trading plan based on this method and have a solid risk management strategy, you can then check the market one to three times a day for ten to twenty minutes each time. If your edge (price action strategies) is showing up than you set up your entry, stop loss, and target and walk away until the next scheduled time to check your trades.
Trading in this manner actually elicits a snowball of positive habits that work to further perpetuate your trading success. This entire article can be summarized by the following two sentenes: People who spend more time analyzing market data and trying to perfect their trading system inevitably induce a cycle of emotional mistakes that work to increase their trading failures and eventually result in lost money and lost time. People who realize that the market is uncontrollable and build their trading plan around this fact will inevitably arrive at a “set and forget” type mentality that induces an emotional state that is conducive to on-going market success and consistent profitability. The trading method used is not as important as the psychological or risk management aspects of trading, but generally speaking, a method that offers a simple high-probability edge such as the price action trading method, is the best method to use to maintain your “set and forget” mindset.

Success in Forex = Learning + Practicing + Update Knowledge