False Breakout Trading Strategy

The ‘False Break’ Trading Strategy (Contrarian Forex Trading)

When was the last time you entered a trade and it immediately moved against you even though you felt confident the market was going to move in your favor? When was the last time you traded a breakout and got stopped out? I’m willing to bet you’ve experienced one or both of these things recently in your own trading, and I’m also willing to bet that me or one of my students probably took the opposite side of one of these trades that seemed to ‘fake you out’ of your position…
You see, false-breaks happen all the time in the markets; they are a result of the ‘herd mentality’ that causes people to buy the top of a move or sell the bottom. As price action traders, we are in a unique position to take advantage of false-breaks and of the weak ‘herd mentality’ that so many amateur traders possess.
I have made most of my money as a trader by using contrarian trading approaches like false-breaks and my proprietary fakey trading strategy. It is the power of contrarian trading and using false-break patterns and fakey setups that allows myself and other savvy price action traders to profit from other traders’ misfortunes. This may sound a little harsh, but it’s the reality of trading that the majority of traders lose money, informed and skilled traders make money, and the ‘pigs get slaughtered’, as the saying goes. I hope there are light bulbs going off in your head now, because this article is all about contrarian thinking, false-breaks, and how to take advantage of the ‘herd mentality’ that causes so many traders to enter right when the market is about to change direction…

So what exactly is a false-break?

I thought you’d never ask! Joking, I know you are probably thinking that right now, so here you go…
A false-break can be defined as a ‘deception’ by the market; a test of a level that results in a break of that level but the market then retracts and does not sustain itself above or below that level. In other words, the market does not close outside of the level being tested; rather it leaves behind a false-break of it. These false-breaks are huge pieces of evidence for impending market direction, and we need to learn to use them to our advantage instead of becoming their victim.
Here is a visual example of a false-break of a key market level:

Essentially, a false-break can be thought of as a contrarian move that ‘sucks’ the over-committed side of the market out. The concept is to wait for the price movement to clearly show that a market has committed to one side of a trade and that they would be ‘forced’ to liquidate their position(s) on a strong reversal in the other direction. Typically, we see these scenarios unfold as a trending market becomes extended and all the amateurs jump in right before the counter-trend retrace, or at key support and resistance levels or at consolidation breakout scenarios.
The herd mentality causes traders to enter the market typically only when it ‘feels’ safe. However, this is the deception; trading off feeling and emotion is exactly why most traders lose money in the markets. Many traders become deceived because the market looks very strong or very weak, so they think it’s a no-brainer to just jump in with that momentum. However, the truth of the matter is that markets ebb and flow and they never move in a straight line for very long. This is known as “reversion to the mean” and it’s something I expand on significantly in my advanced Forex trading course.
We really have to use logic and counter-intuitive or ‘contrarian’ thinking to profit off of the weak-minded herd mentality that dominates most traders’ minds. This is why it’s very important to remain disciplined in the area of trading false-breaks, rejections and failures, and why I love trading them so much.

Types of False Breaks

1. Classic Bull and Bear traps at key market levels
A bull or bar trap is typically a 1 to 4 bar pattern that is defined by a false-break of a key market level. These false-breaks occur after large directional moves and as a market approaches a key level. Most traders tend to think a level will break just because a market has approached it aggressively, they then buy or sell the breakout and then many times the market will ‘fake them out’ and form a bull or bear trap.
A bull trap forms after a move higher, the amateurs who were on the sidelines watching a recent strong move unfold cannot take the temptation anymore, and they jump in just above or at a key resistance level since they feel confident the market now has the momentum to break above it. The market then breaks slightly above the level and fills all breakout orders, and then falls lower as the big boys come in and push the market lower, leaving the amateurs ‘trapped’ in a losing long position.

2. False-break of consolidation
False breaks of consolidation or trading ranges are very common. It’s easy to fall into the trap of thinking a trading range is going to breakout, only to see it reverse back into the body of the range. The best way to avoid this trap is to simply wait until there is a clear close outside of the trading range on the daily chart, and then you can begin to look for price action trading signals in the direction of the breakout.

3. Fakey’s (inside bar false-breaks)
The Fakey setup is one of my all-time favorite price action setups and learning to trade it will do a lot for helping you to understand market dynamics. Essentially, the Fakey is a price action pattern that requires there to be a false-break of an inside bar setup. So, once you have an inside bar setup, you can watch for a false-break of the inside bar and the mother bar. Now, I am not going to get into all the different versions of the fakey trading strategy today or the different ways to trade it, but you can learn everything about my proprietary forex fakey trading strategy in my professional Forex trading course.
Here’s an image of two Fakey setups, note that one has a pin bar as the false-break and other does not, these are just two of the variations of the Fakey setup:

False-breaks can create long-term trend changes

As price action traders, we can use the price action of a market to anticipate false-breaks and look for them at key levels as they will often set off significant changes in price direction or even a change in trend from these key levels.
We need to pay attention to the ‘tails’ of candles that occur at or near key levels in the market. Ask yourself how prices reacted during each daily session…where did they close? The close is the most important level of the day, and often if a market fails to close beyond a key market level, it can signal a significant false-break. Often, prices will probe a level or attempt to break out, but by the close of the daily bar price has rejected that level and ‘tailed out’, showing a false-break or false-test of the level. A failure of the market to close beyond a key market level can lead to a large retracement or a change of trend. Thus, the close of a price bar is the most important level to watch, and the daily chart close is what I consider to be the most important.
Here’s an example of a false-break in the EURUSD daily chart that led to a top in the market and started a long-term downtrend:

History Teaches Us A Lesson
It’s worth noting that on the week famous trader George Soros shorted the British pound and ‘broke’ the Bank of England ( September 16, 1992) -  the chart had shown a massive false-break signal. The chart below shows the price breaking upwards to new highs and then crashing back down. To those who follow me regularly you will note that this was actually a classic fakey setup, and is clear evidence that this price action strategy has worked for decades.

Final word on false-breaks…

As traders, if we don’t learn to anticipate and identify deceptions or ‘false-breaks’ in the market, we will lose money to traders who do. If we pay attention to the price action at key levels on the daily chart time frame, the ‘writing’ is usually on the wall in regards to false-breaks.
If I had to leave you with one crucial piece of advice for your Forex trading career, it would be to drop everything right now and start studying false-breaks and contrarian trading approaches. By doing so, you will be ahead of 95% of traders who are stuck in a cycle of trading off mainstream misconceptions and ineffective trading methods. As a contrarian, I want to be trading when the rest of the retail traders are committed to the wrong side of the market, this can be difficult to do if you don’t understand false-breaks and fakey patterns, but effective nonetheless. Trading false-breaks and my proprietary ‘fakey setup’ is a core focus in my Forex price action trading course, and I expand on these topics in great detail. I teach my students a plethora of different price patterns to look out for when trading false-breaks and fakey setups. This ‘contrarian’ style of trading is something I strongly believe in, and it has proven itself time and time again. If you where to learn only one single trading strategy to apply in your forex trading, this would be on top of the list.