Forex Breakout Trading Method : Drop ‘n’ Stop Trades

How to trade forex breakouts Part 2: Downside Breakout

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This is a companion piece to the first article dealing with support and resistance breakout trading: Pop ‘n’ Stop Trades. Since most of the principles involved are identical, I won’t cover that ground again, but simply show how the strategy also works for breakouts to the downside in forex.

To recap, this is a channel breakout trading system particularly useful around session open times, the simple rules of which I put together after studying London breakout trading and other related strategies such as the New York breakout forex strategy.

The chart to the right shows price breaking strongly to the upside above a narrow range at the left. There were no entries possible on this breakout using the pop and stop method. Price did however form a very nice evening star candlestick pattern at the blue dotted line indicating the weekly pivot. Depending on what other confluences occurred at this level you could have entered a short trade after the first long candle down.

Once price had confirmed the upside breakout and then retraced with another savage breakout to the downside, it stopped just below another weekly pivot. The action here is indicated by the white circle. At first, price rejects several times from a round number (grey dotted line) before finally confirming that the move is on with a bearish rejection bar candlespiking down from the weekly pivot.

To be honest, this is not an ideal trade: price has already exhausted a lot of traders in the move up and the subsequent long, sharp move down. In other words, and to put it more technically, much of the average daily range is bound to have been consumed by this point. There is also the issue of that round number in front of any short trade. However, I’ve provided it for the purpose of illustration, to show that the strategy can work when combined with price action.

Notice how price broke below the round number and then continued to come back and reject from it to the downside. Price did eventually resume its downward move but this most probably would have resulted in a breakeven trade, or perhaps a 1.5:1 winner.

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The next chart shows price failing at the polarity indicator at the top of the chart and then breaking, in increasingly strong bearish candles to the downside from the range that preceded it to the left. The Drop’n’Stop occurred at the first white circle, but there was no confirmation from a bearish rejection bar to enter the trade. Exercising some judgement here, a trader could have entered after the close of the bearish candle at the right of the circle, with an entry perhaps one or two pips below the monthly pivot (dashed line).

The second white circle shows another drop and stop scenario, again with no really convincing bearish rejection candlestick to confirm the move, although the bearish candle at the right of the circle does represent a slightly risky, almost-rejection-bar candle entry.

Either of these entries, though not ideal, would have paid off. Eventually though, the move was exhausted at that round number visible at the bottom of the chart, forming lots of rejection spikes from it. Note that the final confirmation of a reversal was itself a bullish rejection candlestick from the round number. When the next candle closed above the range of this final Drop’n’Stop area, it signalled that price in all likelihood was going to drift back upwards.

As price drifted back up it eventually closed above the polarity stream (the yellow indicator). At this stage, yet another strategy presents itself: the Bladerunner Reversal. But that is a topic for another post…