Understanding Breakouts and Fakeouts

In trading, breakouts and fakeouts are critical price movements that can either lead to profitable opportunities or costly mistakes. A breakout occurs when price decisively moves beyond an established support or resistance level, potentially starting a new trend. A fakeout, on the other hand, is a deceptive move where price briefly breaks a level but quickly reverses, trapping traders who followed the false signal.

Importance for Trading

Understanding breakouts and fakeouts is crucial because:

• Genuine breakouts often lead to strong trending moves and significant profits
• Fakeouts can cause painful losses if not identified quickly
• They occur at key decision points where risk/reward ratios are most favorable
• Distinguishing between them separates successful traders from struggling ones
• They represent moments of maximum opportunity and maximum risk

The Airport Security Story

Meet Carlos, a frequent traveler who often observes the security checkpoint at his local airport. His observations perfectly illustrate how breakouts and fakeouts work in everyday life.

The Morning Breakout

Every weekday morning, Carlos notices that the security line has a consistent pattern. Between 5:00 AM and 7:00 AM, the line stays contained within a certain area, never extending beyond the coffee shop (resistance) or shrinking shorter than the airline check-in counters (support).

One Monday morning, Carlos arrives to see something unusual. A large tour group has arrived, and for the first time, the line extends well past the coffee shop, with no signs of shortening.

"This is a clear breakout of the normal pattern," Carlos thinks to himself. "The usual containment level has been decisively broken, and this line is likely to remain long for quite some time."

Carlos immediately adapts to this new reality. Rather than joining the line, he heads to the airport's secondary security checkpoint, saving himself 30 minutes of waiting.

"A true breakout isn't just about crossing a line—it's about crossing it with conviction and staying there. When you see a genuine breakout, the smart move is to quickly adapt to the new reality."

This mirrors a trading breakout—when price moves decisively beyond a well-established support or resistance level with strong momentum and volume, signaling a potential new trend direction.

The Weekend Fakeout

On Saturday, Carlos arrives at the airport and sees the security line momentarily extend past the coffee shop. "Aha! Another breakout," he thinks, and starts walking toward the secondary checkpoint.

But he pauses to observe for a moment. He notices that unlike Monday's situation, there's no tour group—just a temporary backup because only one security scanner is operating. Within five minutes, a second scanner opens, and the line quickly shrinks back to its normal range.

"That was a fakeout," Carlos realizes. "The line briefly broke past its normal boundary but quickly returned to its typical range. If I had immediately reacted, I would have wasted time going to the farther checkpoint for no reason."

"A fakeout is like a head fake in basketball—it looks like it's going one way but quickly goes another. The key is to pause and confirm the move before committing to action."

This scenario perfectly illustrates a trading fakeout—when price briefly breaks beyond a support or resistance level but quickly reverses, trapping traders who entered positions based on the initial break.

The Holiday Rush Breakout with Retest

During the Thanksgiving holiday, Carlos notices something interesting. The security line breaks far beyond the coffee shop (resistance) due to holiday travelers, establishing a new normal length. However, after an initial surge, the line briefly shrinks back to touch the coffee shop area before extending long again.

"This is fascinating," Carlos observes. "The line broke out beyond its normal boundary, then came back to 'test' that boundary, and now it's extending again. The old resistance has become the new support."

"When a breakout occurs and then price returns to test the broken level, it's like checking if a door is really unlocked. If the level holds in its new role, it confirms the breakout is genuine."

This illustrates a classic trading pattern—a breakout with retest, where price breaks beyond a level, returns to test it in its new role (resistance becomes support or vice versa), and then continues in the breakout direction.

Using Breakouts and Fakeouts in Real-Time Day Trading

How to Identify a True Breakout

Real-time example: Apple stock has been trading between $170 (support) and $175 (resistance) for two weeks. Today, it opens at $174 and by 10:30 AM, it pushes through $175 with volume that's 200% above average. By 11:00 AM, it's trading at $177 with continued strong buying.

How to use it: This shows characteristics of a true breakout:

• Strong volume on the break
• Decisive move beyond the level (not just touching it)
• Continued momentum after the break

"Volume is the fuel that powers a breakout. Without it, your breakout vehicle will likely stall and reverse."

Action plan: Enter a long position after confirming the breakout is holding above $175 for at least 15-30 minutes. Set a stop loss just below the broken resistance (perhaps at $174.50) and target the next major resistance level or use a measured move (the height of the prior range added to the breakout point: $175 + ($175-$170) = $180).

How to Spot a Likely Fakeout

Real-time example: Netflix has been trading between $400 (support) and $420 (resistance). It suddenly spikes to $422, breaking resistance, but volume is below average and the candle has a long upper wick (opened at $415, went up to $422, but is closing at $416).

How to use it: This shows warning signs of a potential fakeout:

• Low volume on the break
• Failure to close strongly beyond the level
• Long wick showing rejection of higher prices

"A breakout without volume is like trying to jump a car with a weak battery—it might move briefly but will soon stall."

Action plan: Either avoid entering a trade based on this suspicious breakout or wait for additional confirmation. If you've already entered, consider tightening your stop loss or taking profits quickly if momentum fades.

Trading the Breakout Retest

Real-time example: Tesla breaks below important support at $220 with heavy volume, falling to $210. The next day, it bounces back up to $219-$220, touching the old support level from below, then starts falling again.

How to use it: This is a classic breakout retest pattern:

• Initial breakout with good volume
• Return to the broken level (old support becoming new resistance)
• Rejection from that level confirming the new trend

"The retest of a broken level is like a second chance to enter the trade if you missed the initial breakout."

Action plan: Enter a short position as price fails at the retest of $220, with a stop loss just above $222. Target the recent low of $210 initially, with potential to ride the trend further if momentum continues.

Practical Tips to Avoid Fakeout Traps

1. Wait for confirmation: Don't rush to enter immediately when a level breaks; wait for at least 15-30 minutes to confirm it's holding.
2. Check the volume: True breakouts typically occur with above-average volume; low volume breaks are suspicious.
3. Watch the close: A candle that closes decisively beyond the level is more reliable than one that merely wicks beyond it.
4. Consider the time of day: Breakouts during the first and last hour of trading can be more volatile and prone to fakeouts.
5. Look for prior attempts: A level that has been tested multiple times before breaking is more likely to produce a genuine breakout.

Remember, breakouts and fakeouts represent the market's decision points. By learning to distinguish between them, you position yourself to follow the smart money rather than being caught in traps set for impatient traders. As the saying goes, "The amateur gets excited by the break; the professional gets excited by the confirmation."