In this article we will look at how to use the volume indicator to identify breakouts versus fakeouts.
Breakout = a price movement outside an expected support or resistance range that is backed by high trading volume.
Fakeout = when a setup that looks like a breakout fails.
Breakouts tend to happen after periods of reduced volatility at the end of patterns, and often signal a trend reversal attempt by market participants. A breakout can be a strong sign that the price will keep moving in the direction of the break.
But sometimes what looks like a breakout may not play out as anticipated, becoming more of a fakeout.
Example 1: XRP/USD 15m
In this 15m chart for XRP/USD, you can see repeated support tests at USD0.365 with a series of lower highs. This suggests that bulls have enough support to defend the USD0.365 area, but they do not have the necessary momentum to push price to higher lows and higher highs.
Eventually, the bears are able to push through with an initial candle that definitively closes under the support range. After that, more bears rush in to sell and short XRP after a successful support break.
This XRP/USD example has all the makings of a classic breakout - XRP is moving in a clear descending triangle pattern with a high volume support break at USD0.365 after experiencing a volatility and volume dropoff.
Example 2: BTC/USD 1h
In this one-hour chart for BTC/USD, BTC is clearly trading in a descending channel forming lower highs and lower lows. In this kind of chart pattern, the top line is called the main trendline, while the bottom line is called the channel line.
During a descending channel, breakout traders look for two key signals: a support formation above the channel line followed by a high volume breakout to the upside.
Over the course of this descending channel, you can see BTC/USD’s volume profile drop consistently as bulls and bears get exhausted. At the end of the channel, BTC manages to find support at $9400 – a clear level above the channel line and suggests that bears no longer have the momentum to push price back down to test the channel line.
What follows is an opportunity for bulls to take advantage of the bears’ weakness with a high volume move to the upside that breaks the main trendline.
Coincidentally enough, the chart above also shows a fakeout, which you can think of as a fake breakout that isn’t supported by high trading volume. After touching the channel line multiple times, BTC briefly fell through the support zone around February 23.
Over the next few hours, the channel line actually became a temporary resistance. Without looking at the volume indicator, this move appears to be a clear sell or short signal. However, BTC’s volume profile during that support break is contradictory and doesn’t show high trading volume to back up the support break.
Volume and candle analysis are perhaps the best indicator combination for identifying a real breakout. In summary, when trading breakouts, the key indicator to look for is a break in an established support or resistance level that is sufficiently backed by high trading volume.
This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product.