Building A Better Breakout System Using Simple Filters PDF
Building A Better Breakout System Using Simple Filters PDF
Building A Better Breakout System Using Simple Filters PDF
Building A
Better Breakout System
Using Simple Filters By Steve Misic
Technical Analysis Tackles Breakout and frustrating trades when shortly after entering the breakout or breakdown,
Breakdown Trade Techniques price goes a few ticks above or below the entry price, and then suddenly
reverses leaving the trader with a loss. There are a few ways to improve
There are several types of setups that traders look for when placing the likelihood that the breakout or breakdown trade will result in a win
long trades and short trades.Two of the most popular setups are known rather than a loss by selecting which breakout and breakdown trades
as the trading range “breakout” for a long entry, and the trading range to enter, and then entering the ones with the better odds of success by
“breakdown” for a short entry. After moving vertically for a period of using a simple filter system. This article explains the filters I use when
time, the price will often consolidate before resuming its vertical move in deciding on which breakouts and breakdowns I believe will give me the
either the same direction, or in the opposite direction. When prices trade best chance for success.
sideways, the bars or candles will often have similar highs and similar The first filter I use to determine which breakout or breakdown trades I
lows. If there are two identical highs or two identical
lows, a trading range can be defined. This method
of defining a trading range will work regardless of
whether the trader uses a time chart, or a volume
bar, or tick chart.
Once defined, the trader places a horizontal
line on the highest high of the range and another
horizontal line on the lowest low. If the price suddenly
breaks above the highest high of the range, a long
trade is entered using a buy stop a few ticks above
the highest high as the entry point. For a short trade,
a sell stop is placed a few ticks below the lowest low
to be used for the entry point. Some traders prefer to
use channels or bands to define their trading range
because both will follow price as it moves around
automatically, but most prefer using horizontal lines
which can give a trader a better visual view of the
top and bottom of the trading range, or trend lines
which help assist traders in determining the most
likely direction of the breakout.
While breakout and breakdown trades are
among the most popular, both can also be very
(Figure.
(Figure.1)1)
26
take on a small time frame entry chart is the overall trend from the higher focus on the long term picture, because the short term trend on my entry
time frame charts. Breakout long trades will have better win rates if the chart will often show a completely different or totally opposite picture.
instrument being traded is currently in a medium to long term up trend.
Breakdowns will have a higher success rate in markets that are topping Higher Time Frame Trend And Visible Support And
out, or have already entered short term down trends. In addition to the Resistance
trend, when I look at higher time frame charts, I am looking for visible
areas of support and resistance that need to be broken for a breakout or Let’s take a look at a 15 minute, two day chart of the British Pound futures
a breakdown trade to be profitable. (Figure. 1) contract, and a 180 minute, 5 day chart for an example of how to use
Having a few concentrated bars or candles like those on a daily or this filter. (Figure. 2)
180 minute chart will provide a clear picture of the obstacles to success I use a lower time frame chart as my entry chart which varies with
on the entry chart. If the market is visiting an area of resistance or the instrument I am trading. Some of the less liquid futures contracts or
support on a higher time frame for the first time, I will avoid breakout stocks I trade will push past smaller time frame support and resistance.
and breakdown trades all together. These areas will produce higher time Moving to a slightly higher time frame often solves this issue.
frame retracement trades which will lead to many of the smaller time The 15 minute chart works better than the 5 minute chart for me when
frame whipsaw reversals that breakout traders often experience. If the I trade the British Pound futures because of its liquidity. This was a trial
area of support or resistance on the higher time frame has been visited and error discovery, and will vary from trader to trader. The 180 chart
several times, it becomes a better candidate for a winning breakout or clearly shows the trend for the British Pound futures is, and has been up
breakdown trade in the same direction as the macro trend. on the higher time frames, and the picture of the 15 minute entry chart
As a visual aid, I use color coded horizontal lines to identify new or shows the Pound Sterling at a 27 year high against the US Dollar at 2:00
old support and resistance. For support, I use blue for new and yellow AM Central time on this day.
for old, and for resistance, red is new and yellow is old. These colored Visual resistance is not an issue; however, unseen resistance in
lines help my mind make decisions faster without having to look at any the form of option barriers is still a very real possibility in the currency
other charts during the trade. Another reason for knowing higher time markets. Many of the institutions use options to hedge or speculate in
frame support and resistance would be for a pullback entry to join the the currencies. Some option barrier strategies when placed near whole
macro uptrend or downtrend with a minimal amount of risk. For example, numbers act as resistance.
to safely enter a market that is in a macro up trend, I will find the area of There were two successful breakouts on this 15 minute chart. The
support on this higher time frame that I would buy a pullback to to join the first breakout past the resistance near 2.0574 is a much cleaner looking
uptrend. Breakdowns into these support areas will be avoided since they trade than the higher breakout past 2.0662. The main reason is the first
are less likely to produce consistent winning trades. Limiting the losers in breakout trade happened near the higher time frame support as seen
a breakout or breakdown system using this first filter will lead to a fewer on the 180 chart above, whereas the second breakout trade was near
number of overall entries, but it will not improve the amount of profit per the contract high where it may have been influenced by option barrier
entry when used by itself. This will be addressed in the next two filters. strategies.
In summary, by finding support and resistance on the higher time The next filter I use helps improve the entry point, and further explains
frame chart, and trading with the macro trend, I can force my mind to the logic I use for selecting the better odds trades.
(Figure. 2)
(Figure. 3)
28
catching up to the higher trading range from below. range by the candle just before the breakout candle which closed above
Using the 30 WMA being a part of the trading range as a condition the top of the range, but below the breakout point. The 30 WMA is now my
for entry, I would now need both the 30 WMA being part of the trading trailing stop in case there was a retest of the range. (Figure. 4)
range, and for price to be above the highest high for the breakout long The breakout has to be considered successful at this point. During the
trade to be valid. For a valid short entry, price would need to be below time I have been writing this article, the 30 WMA has managed to move
the 30 WMA and the lowest low of the range for a valid breakdown short up to 2.0682. At this point, I will use a trade below 2.0682 as my exit for
to trigger. Trades where the 30 WMA is not a part of the trading range a break even stop. If the British Pound continues higher from here, the
prior to entry are ignored. higher trading range that is forming between 2.0710 and 2.0690, and the
Once the entry happens in either case, a pullback to the breakout rising 30 WMA will act as protection for my breakout entry. If the trade
price or back in the range is always possible. There is a condition I use is cut short, a breakout above the highest high of the new range above
for ending the trade early that depends on the close of the breakout or or a pullback to the breakout point at 2.0662 below would be two other
breakdown bar. My rule for using the 30 WMA as a stop loss is that if I take options for a re-entry. In the event of the retest of 2.0662, I will use the
the breakout long entry, and the breakout candle closes above the highest lowest low of the original trading range below 2.0642 as the initial stop for
high of the trading range, I will then use the 30 WMA as a trailing stop right a pullback entry or the lowest low of the higher range as the initial stop for
away. I use the lowest low of the trading range as my initial stop in case I a breakout entry above and the 30 WMA as a trailing stop from there.
am dragged back into the trading range during a false breakout. In summary, the factors that contribute to a successful breakout
A false breakout is a breakout bar that returns to the trading range system should include a simple set of filters like the ones above to
before it closes. Once the breakout candle closes above the top of exclude breakouts or breakdowns that have the least chances of success.
the range, if price retraces immediately back to the trading range, the Additional filters described below can add to your decision making process
breakout line would need to provide support. A trade below the 30 WMA for further confirmation:
at this point would be an early exit, and the breakout would be a failed
breakout long trade. For breakdowns, the initial stop is above the highest i. Check for the macro trend, support and resistance on higher time
high of the range until the breakdown candle closes. If it closes below the frames for a more organized view of each factor. Use buy stops
lowest low of the trading range, the 30 WMA will start to trail the trade. above the highest high on the higher time frame like a 180 minute
The British Pound breakout long that happened above 2.0662 had chart if you have a problem finding the top and bottom of the range
several false breakouts which are marked with red arrows. In each case, on the entry chart. Breakouts on smaller time frames such as the
the breakout bar is the bar that retraces back inside the trading range. 3 minute or 5 minute time charts or 50 to 200 tick charts are also
Entry could have been on any one of those bars that went 3 ticks past the possible for even earlier entries, as well as breakouts on 60 minute
previous bars high. At this point, using the 30 WMA as the initial stop loss or 180 minute charts for swing trade entries.
would have led to four failed breakout entries. Having a wider initial stop ii. Be aware of the previous day’s trading range and the location of
would have approximately the same dollar loss as four entries and exits price inside that range.Breakouts from the previous day’s high end
when commissions and fees are considered. of the range will fail more frequently if the macro trend is sideways
On the last chart above, the breakout candle that closed above the to down.
highest high of the range at 2.0680 went on to hit a high of 2.0710 before iii. Use a moving average as a filter for deciding which trades you take,
retracing to a close of 2.0690. Notice that there was no retest of the and as a trailing stop or as an early exit, if necessary. Location of
the moving average inside the range can help determine if price is
in consolidation for a move higher or lower. On the British Pound
trade, notice how the 30 WMA kept rising inside the trading range
before the breakout at 2.0680 rather than sitting near the bottom
of the range. Another clue was the ascending triangle that formed
inside the range. Use volume on the breakout if you need further
confirmation.
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(Figure. 4)