Choosing a forex trading strategy that can be robust and offer you consistent profits, but is simple at the same time, can be tricky. Before going into the details of this trading strategy, it is smart to open a demo trading account, so you can practice the strategy until you master it.
The easiest way to trade breakouts is by setting your strategy on a Meta Trader platform.
Traders often tend to make the mistake of believing a successful forex trading strategy needs to be complex. This myth partly comes from high frequency trading, quants and other such terms. These are specialized sections of trading that focus on building the ultimate trading strategy to yield profits.
Still, if you dig a bit deeper, and especially look at history, you will find that some of the most successful traders, be it in stocks, forex or futures, have used a very simple trading strategy.
Rewind to a few decades ago when trading and chart analysis was mostly relegated to paper, and with no computers, traders of that era had to rely on making trading simple. There have been quite a few successful traders, and a complex trading system was definitely not what they followed.
Trading capital and leverage
While any trading strategy can be applied, irrespective of the forex broker, traders need to consider the spreads, swaps, margin requirements and so on. These often-overlooked aspects are actually the basis of a successful trading strategy.
Most of the forex brokers offer leverage up to 1:500 and a minimum lot of 0.01. The brokers mostly differ by the size of spreads, and traders are naturally interested in tighter spreads.
If you are looking to trade forex, $500 starting capital is the bare minimum. Ideally, it is best to start with a capital of $1,000, so you can build a successful equity by following the strategy.
Trading the day’s breakout
One of the advantages of trading currency pairs is that traders can use very high leverage. This also means traders can start with small positions, such as 0.01 lots, and eventually increase their contract sizes as they go along and gain more confidence.
In our example, we will use the EURUSD currency pair. The benefit of trading the EURUSD is that it is one of the most widely traded currency pairs. Thus, spreads are low, and you can take advantage of the volatility.
Before you trade the day’s breakout, you must switch to a 1-hour chart. Make sure to have the period separators enabled on your MT4. The shortcut is Ctrl+Y.
Step 1: Plot the previous day’s high and low prices
Once you have the period separators, you can now see the previous day’s high and low prices on the chart. The first step is to plot the previous day’s high and low prices using the horizontal line tool.
Once you have the price levels, the next step is to wait for this level to be breached. Obviously, when the price breaks the previous day’s high, we take a long position, and when the price breaches the previous day’s low, we take a short position.
Step 2: Price action breakout
Now, the second step is to understand how the price breaks the previous day’s high or low levels. This is where it gets interesting. We look for a strong bullish or bearish candlestick that will break the high or the low levels of the previous day. Ensure that at least 50% of this candlestick closes outside the high or the low.
In the above chart, you have two scenarios. The first scenario (to the left) is incorrect price action. Although the price broke out and closed above the previous day’s high, you can see that price did not close at more than 50%.
Thus, the setup is invalidated.
In the next scenario, to the right, you can see how the price closed strongly and more than 50% outside of the previous day’s high. This is the right set up and can be traded.
Long and short positions
Now that we understand how to identify the right candlestick and price action, the next step is to look at how to take long and short positions. The trading rules are simple.
Day’s breakout - Long position example
For a long position, wait for price to open below the previous day’s high but close more than 50% outside the previous day’s high. After you identify this candlestick pattern on the 1-hour chart, take a long position on the next candle open. Set your stop loss to the previous candle low and target a 1:2 risk reward set up.
Here, after the candlestick closed more than 50% outside the previous day’s high, a long position was taken after the next candle opens. Stops were set on the low, and a 1:2 risk reward target could be set up.
Day’s breakout - Short position example
For a short position, the same concept applies, except the price action must close inside the previous day’s range and close more than 50% outside the previous day’s low.
In the short position above, you can see the price action briefly opened inside the previous day’s range and closed more than 50% outside. Thus, a short position is taken here, and with a 1:2 risk reward ratio, this would have resulted in a decent profit.
Comments by traders
The trading strategy outlined offers a good system to trade. To be a successful forex trader, you need to be patient and wait for the right moment to enter a trade. Trading the breakouts is a very simple pattern, and traders can use it to profit on the forex markets.
If you are willing to trade based on the breakout method, it is ideal to make at least 30 trades before you analyse whether this strategy works for you. You can also post your strategy outcomes in the comments below.