Due to the huge liquidity involved and the massive amount of competition in the forex market, it could be argued that currencies trend less often than other markets such as commodities or bonds. Indeed, currencies manage to stay relatively stable, moving only in small amounts, and it’s for this reason that leverage is almost always applied in the forex markets.
Because of this fact, breakouts in the forex markets often turn out to be whipsaws; fake breakouts that head south almost as soon as the trade is placed.
As a trader it is important to increase your chances of trading only the real breakout patterns and avoid the fake ones. Here’s some methods that traders use to clarify whether a breakout might be real or not.
Volume is always a good guide for confirming a breakout as it is one of the few indicators that does not move in relation to the price and it works particularly well in stocks.
Forex volume, however, is not always shown in non-ECN brokers and when it is, it’s usually the volume from that particular broker, not the market itself. It’s for this reason that some currency traders think volume is pretty useless in forex but this isn’t the case.
Most of the time, if you look at various different brokers, they will all show very similar volume levels. Thus if a breakout price move is accompanied by strong volume, it’s still a very good indication that the breakout is good. If volume is low, the breakout could well be fake.
Another way to tell if a breakout is real is to ask whether the breakout is based on anything fundamental. News stories and breaking events move markets the most and that’s why traders often trade around news releases.
Therefore, if a breakout is accompanied with a news releases, it’s another good sign that the breakout is real.
Your own view
Sometimes it can be enough to simply look at your own fundamental view to ascertain whether a breakout is real or not. In other words, if you have done your homework and have been waiting for a breakout for a while, chances are that the breakout will be real and go on for a decent amount of time.
Conversely, if a breakout has occurred and you cannot find a reason for why, then it’s probably a whipsaw. Even if it isn’t, it’s probably safer not to trade it.