A breakout is an event where the price of a crypto (or stock) goes above a certain price (resistance) that was difficult to cross in the past. A trading strategy using this breakout to make money is called breakout trading.
Usually, after a price breaks out of a certain resistance, it keeps on going higher because the crypto has very high momentum during a breakout.
A low-momentum price action can never cause a breakout, and even if it does, it will soon return below the resistance. Such moments are known as false breakouts.
What is a Breakout?
A breakout is an upward movement in the price of a cryptocurrency (or stock) above the level that the cryptocurrency had tried to overcome in the past but was unable to do so for various reasons.
Usually, breakouts are either caused by strong fundamental changes in the markets, news events, or the expectation of such events in the future.
For example, the expectation of a positive regulatory environment under Donald Trump led to the breakout in Bitcoin and several other cryptocurrencies in late 2024—even before Trump became president.
How To Trade Using Breakout Trading?
Usually, I use the below method which yields me decent gains and also saves my capital.
This method has four steps for identifying a genuine breakout: identifying a potential breakout, confirming it is a genuine one, fixing a target, and setting a stop loss.
Identify
The most challenging part of breakout trading is identifying the chart pattern that could trigger a breakout in the future.
In my experience, I have seen such chart patterns forming in those cryptocurrencies which have the following attributes:
- Had achieved a high price in the past but could not sustain.
- Have high liquidity, i.e., usually among the top 50 cryptocurrencies; the larger, the better.
- Have a strong fundamental or have strong community support.
Further the crypto markets too should meet a few conditions.
- Large events in the near term like elections, GDP data release, unemployment figures release, and interest rate decisions.
- Some kind of fundamental shifts are taking place in the markets, such as growing adoption rates for crypto or the end of a long bearish trend like crypto winter (March 2022 to Jan 2023).
- Fundamental changes in regulatory outlook like anti-crypto to neutral or from neutral to pro-crypto.
Under such conditions, you will see a preemptive rally in cryptocurrencies. In 2024, we saw one such rally in the pre-Bitcoin Halving period. Those cryptos where these preemptive rallies occur are the top candidates for Breakout Trading.
Confirmation
Breakout must be checked for confirmation. Otherwise, users will get stuck at a higher level called a Bull Trap.
Usually, we use two or more indicators to confirm. Two are recommended. More indicators add to the confusion and have little benefit. We typically use RSI and MACD. RSI levels should be rising, and MACD should be in a positive crossover zone.
Other useful indicators are Elliott Wave, Bollinger Bands, and 50 and 200 Days EMA.
Set Target
The second step in breakout trading is to set the target which is usually at the highest level in the recent past. Say if XRP has broken out of $1 and above this $1.1 was the previous highest level achieved by XRP, then the target is around $1.1.
Understand this from another angle, the target of the breakout is the next resistance level in the crypto.
Set Stoploss
Many traders grossly overlook setting a stop-loss, but in case of a large rally or crash in the market, stop losses prevent the erosion of capital due to one wrong trade.
Take Profits
Taking profits is the most important thing in any type of trading.
Novice traders trade crypto without any target, technical charts, strategy, or stop loss and hence lose money.
However, experienced ones arent’ much far. They get everything correct, from targets to charts to stoploss but still lose money because of greed. Once their targets have arrived, traders several times wait for what plays next and simply think that the market will keep on going up. A sudden profit booking at higher levels crashes their expectations, and traders often return empty-handed, if not with a big loss.
Therefore, taking profits is of utmost importance. But how to decide when to exit?
- If you are seeing charts for making a trade, see where the resistance is and book partial profits there. Keep on booking 50% of the remaining amount for every 10% or so gain.
- If you are using indicators, wait for these indicators to turn neutral from bearish (short trade) or bullish (long trade).
- If you are trading with option open interest (OI) data like many of us, notice a shift in OI values and book profit when this shift occurs.
How to Identify and Avoid a False Breakout?
When the Market Shows Clear Indications
Identifying a false breakout is sometimes easy when there are clear indications, such as the market being bearish, no positive news, or the greed and fear index being low. In such cases, do not trust the breakout.
For example, Bitcoin crossed $70k in mid-March 2024 and made 7 false breakouts above $65k in an attempt to make a new ATH. However, each time, the breakout fizzled, and bull traders lost money.
When There Isn’t Any Indication
In such cases rely on stoploss to prevent any unnecessary capital drawdown. Keep a suitable margin after your traded price (say 5%) and put an automatic stoploss there. Most exchanges and derivative trading platforms support automated stoplosses these days.
For example, if you bought X crypto at $10 thinking it will go up to $13. Put a stoploss at 5% capital drawdown, say at $9.5 so that even if you get it wrong, you will lose only 50 cents. Crypto markets are often highly volatile and cryptocurrencies may make very large losses in a single day.
