A fakeout occurs when price tricks you into a false breakout, only to capture your trade and move usually in the opposite direction and with renewed momentum. Some might even call this a stop hunting technique. This is frequently seen even with trend lines and not just horizontal breakouts or candlestick breakouts.
To reduce the chances of being caught in such fakeouts, the first step is to plot the trendline of course. Once you do that, we know that long or short positions can be taken when price breaks the rising or falling trend line. In Figure 1, we have a classic breakout from the rising trendline. This is quite straightforward.
You sell on the breakout and price, fortunately, did not move back higher. Now the next chart shows what can also happen with trendline breakouts.
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In Figure 2, after plotting the trend line, we notice not once but two instances of a fake breakout. Price slips lower, only to move back higher. Then, a lower high is formed which gives the impression of a correction that is about to happen. Unfortunately, even in the second attempt, the price makes a fake downside breakout before rallying higher. The final breakout did indeed push price lower, but by this point, most traders would have given up on this setup. So how can we stay more alert and avoid these potential fake breakouts? Using divergence is a simple but effective way to avoid fake breakouts.
By using this method, a trader can only look for qualified breakouts. A hidden divergence or reverse divergence can be a bit complex compared to regular divergence.
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But it is quite simple really. Bullish hidden divergence occurs when price makes a relative higher low, but the oscillator makes a relative lower low. When applied to trend lines, traders can simply look for this set up to occur. So, with a rising trend line, we look for short positions that are validated by the trend line break and a pullback to the breakout confirmed by the hidden bearish divergence.
Using hidden divergence to qualify breakouts
With a falling trend line, we look for price to first break out but pull back to make a higher low. The divergence here should be a hidden bullish divergence. Because in both cases price makes a lower high and a higher low, the stops can be placed around the recent pivot high or low. If the above seems complicated, look at the chart below which illustrates this concept.
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So far, we have identified what to look for to validate a trend line break. But this still leaves out an important point. Where do you place your entry, stops, and profits? Trades can be entered at the low for rising trend line break short positions or at the high for falling trend line break long positions that was formed after the breakout from the trend line.
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The stops are placed at the lower high for short positions or, the higher low for long positions. For-profits, you can either set a fixed reward of two times the risk or book partial profits at the most immediate support or resistance level. All materials are published for educational purposes only. Not only does a trend line show the current trend direction, it also suggests levels of Support and Resistance for the current and future market price. More so it helps finding good Entry and Exit points, e. Shall we learn how to draw trend line to help us find profitable trading opportunities?
How to Draw a Forex Trend Line?
In an uptrend market the trend line is drawn below the pattern formation; in the downtrend — above. Note the rule of placing trend lines for uptrend and downtrend. For uptrend a trend line is plotted below the price action to indicate a support level. For downtrend — above the price action to mark the level where resistance occurs.
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That's why we want to find a direction of the trend. Price can form channels. A channel is a corridor with parallel lines in between which the price moves. The longer the price stays in a channel the stronger the channel becomes.