How I Trade False Breakouts
Have you ever watched price action surge to new highs or drop to new lows, only to immediately reverse course in pure v-turn fashion and head the other direction post-haste? Of course you have. Anyone who has traded for awhile can recall seeing instances where price action makes a new high or low and promptly reverses course right there to mark the extreme peak turn.
Those memories are especially vivid for traders who bought/sold the breakout to new levels OR bought/sold the pullbacks that followed peak extremes only to be stopped out of all. How can we tell a deliberate trending continuation move from one of those new-high/new-low sudden reversals that consistently trap longs and shorts alike?
Where It Occurs
Bull and bear traps. 2B patterns. Wycoff Springs. Different names for the same general price patterns. The act of deliberate price discovery where recent low or high swing points get exceeded by a little bit, then reverse hard from there. Resistance and support are merely descriptions we label to locations on a chart where buying or selling ceased and the opposite ensued. For whatever reasons, buyers stave off sellers at support and sellers stave off buyers at resistance. Those relative values are invariably tested for continued support/resistance OR break and reversal of same into the future.
Stop-loss orders tend to cluster around predictable price zones. Traders are human and humans are predictable with patterned behavioral response. We all see the same general points of interest in a market: prior session range values, long-term moving average values (50 day, 200 day, etc) open gaps, historical resistance and support, long-term trendlines… various measures of pertinent price action. These groups of buying or selling pressure resting at key locations is fundamentally what creates support and resistance respectively. Price stops going down when buyers overcome sellers. Price stops going up when sellers overcome buyers.
Simple, really. Something that big market players realize and exploit. Something they’ve done since the inception of markets and trading. Double tops and bottoms, trendlines and breaks are amongst the oldest possible forms of technical analysis that exist.
How It Occurs
Think of these spring-trap patterns as defining moments on a chart for price reversal setups and confirmation. At swing high or low areas where price held before, a new test of those levels breaks through by a small margin. Could be just one tick or up to a couple of index points in distance, depending on market > timeframe of chart viewed. The key is an immediate or almost immediate reversal back through the break of prior swing high/low with emphasis. If the market breaks a significant value at prior highs/lows and hangs around there for awhile, we really can’t call that a spring. If the probe goes through a significant value with emphasis (spike or plunge) and pops back out in equal fashion, we probably have a good old stop-gun reversal in out sights.
Five-minute view in the S&P 500 e-minis above shows a classic trap-spring pattern unfold. It actually forms a bearish evening star reversal pattern via bullish (green) bar, sideways (doji) bar of indecision and bearish (red) bar to completely erase the upside pop. Notice where this spike high pushes through the prior high and drops right back below in rapid fashion. That’s a clear example of buy stops being triggered en masse, placed just above the prior swing high as protective buy-stop to close for open shorts AND buy-stop to open for pending longs. Two different groups of traders placing similar stop orders in a known, obvious location that cause the same effect: pressure price action higher when hit.
Do you think it’s reasonable to assume veteran market players know where clusters of stop-loss orders tend to congregate? Human behavior in group fashion is extremely predictable and easily patterned. Probing price prints above zones of resistance and/or below zones of support strike the match on dry tinder of stop orders, sparking a quick blaze higher or lower that quickly fizzles when stop orders get filled. There is no continuation of buying or selling into those false breaks. Matter of fact, the big-money traders who levered those tapes through the clustered stops used that liquidity for filling block orders. The false breakout through buy stops pictured above were immediately sold into by orders as big or bigger than the order flow up. It was that selling pressure to fill the purposely triggered stops that drove price back down in v-turn fashion, right through support and back down again.
Dialing down the same price pattern inside a one-minute chart shows detailed picture. Quick spike up represents resting stop orders getting whacked out at highs, right before the surge bars lower depict sell orders deliberately filled by that created liquidity of hammered stops. Clear 1-2-3 pattern down, broke that little pattern and then through prior resistance highs. Plenty of opportunity for different short trade entries there from 940 ~ 939 zone that quickly broke lower in predictable fashion.
Different day, different symbol, different sequence of events… same procedure. Price action inside Russell 2000 emini futures dropped through recent swing low support and immediately fired higher with gusto. Whether each one of these patterns are deliberate traps planned ahead of time OR whether they are a surprise to all market players is really moot: why it occurs never places one dime’s profit in anyone’s account. It is the what and where aspects that make money when trap-spring patterns are witnessed and identified for what they are.
TF 1min chart view dials into the big picture with clearer detail: trap is sprung, sellers to both close existing trades and open new trades are immediately in the red with buy orders now engulfing them. That serves to kick start the buying surge, as hapless sellers to open new shorts find themselves covering with buy-to-close orders that pressures price action higher.
Summation
Fear and greed at work in the marketplace, as always. Just about every trading session has one or two instances of peak price failure or exhaustions that reverse on patterned trap moves. Pure reversal traders can target those as part of their primary mean-reversion technique of trading resistance and support. Directional or trend following traders can likewise use trap or spring patterns as places that warn of pending swing moves ahead. These reversal patterns are also great spots to enter part of a trade position and then add size to that when price movement pushes away from the zone and confirms a reversal has likely begun.
But those are topics for complete conversations another time. Enough in itself for traders to learn the habit of watching for such patterns and using them to base near-term price predictions from. Slightly higher highs and slightly lower lows that snap back with energy usually print very clear candlestick reversal patterns. Bar chart traders see the same general things in different light. Overall these are key footprints on a chart that influence price behavior near-term and many times later on in the future. It’s a big step forward to stay out of these price traps and/or position yourself on the correct side of them as patterned sequences unfold.
Austin Passamonte is a full-time professional trader who specializes in E-mini stock index futures and commodity markets. Mr. Passamonte’s trading approach uses proprietary chart patterns found on an intraday basis. Austin trades privately in the Finger Lakes region of New York. Click here to visit CoiledMarkets