Lesson 1: Different Types of Breakouts in the Forex Market

During the past lessons, you’ve learned the importance of knowing your trading environment to apply appropriate and profitable strategies. 

One common trend in the forex market is a breakout, or when the market passes through its current (now previous) support and resistance. How does this help you? A breakout signals traders about the market risks and potential trading opportunities.  

Lesson Highlights

• A trend breakout means the price movement passes through its support and resistance level. When the market breakthroughs its support level, the selling pressure is high. Meanwhile, when it passes through its resistance level, the market experiences extreme buying pressure.
• There are two types of trend breakouts: the continuation breakout and the reversal breakout.
• A continuation breakout represents a market breaking out of its support/resistance level with a continuation trend. On the other hand, a reversal breakout represents a market passing through its support/resistance level after a reversal.

Market Trend and Its Breakout 

You already know that the foundation of trading lies in the economic concept of supply and demand.  

Essentially, when the market has high demand and low supply, its price is likely to appreciate to either capitalize or balance out the supply and demand. Likewise, when the market supply is high compared to its demand, it will decline due to its adjustment to low demand and to sell out high supply.  

When the supply and demand of the market remain consistent for a period, it’s likely to just play around with its support and resistance level.  

The question is, does the market always stay within the current support and resistance? No, the forex market tends to move above its resistance level or below its support level, especially when the supply and demand of the currency pair exceed its previous record.  

The event when the market breaks out from its support and resistance is called... Well, yeah, breakout trend! 

Not familiar with or simply forgot about these? Let’s review, 

• Support and resistance levels refer to the market level where the price is having difficulty penetrating through.  
• Support represents the level where the market downtrend is expected to reverse due to increased buying pressure.  
• Resistance represents the level where market appreciation pauses and then reverses due to increased selling pressure.  

What is Trend Breakout

As mentioned, trend breakout refers to a market event where the price movement passes through its support and resistance levels. It tells you about the change in the supply and demand of the pair you’re trading or monitoring.  

You must know two breakout trends when you’re in the forex market. Having an idea of what kind of breakout you’re in helps you see what is happening to the market and profit from it.  

Continuation Breakouts 

As the name suggests, continuation breakouts refer to an event where the market continues its initial trend. It is a breakout that happens in a range-bound market.  

Range-bound market? It’s a market environment where the price movement pauses and moves in one horizontal direction to take a breather.  

Essentially, it simply suggests that the traders are assessing the next step they’ll take in the market after an extensive bullish or bearish trend.  

Assume you’re monitoring the EUR/USD. During the previous hours, the market was in its bullish trend. 

However, it suddenly moves horizontally, where the market bounces within a specific range during the period. After a few more hours, you notice that the EUR/USD movement passes through the range-bound market and moves upward, continuing its primary trend.  

Reversal Breakouts 

Unlike a continuation breakout, the reversal breakout is a market trend where the movement takes a different direction than its previous trend.  

During this breakout, the market moves in a certain trend, enters a period of consolidation, and then moves in the opposite direction of its previous primary trend.  

Sound confusing? It just shows you that the market reverses its previous movement.  

But beware! Reversal breakout tends to move as if it will continue its primary trend. This initial trend after the consolidation may give traders a false impression of a breakout, resulting in wrong trading decisions.  

Let’s return to the previous scenario, where you monitor the EUR/USD. Assume the market is bullish, continuing its earlier trend after the consolidation. After a few more hours of monitoring, you notice that it enters a period of consolidation again.  

However, after the consolidation period, the price movement didn’t go upward but trended downward. It moves in the opposite direction from its previous trend. 

For the upcoming lessons, you’ll explore how to spot a breakout and the best practices to trade breakout trends.