The market moves in three directions:
When the market is not in a trend (no higher highs/higher lows and no lower highs/lower lows being produced) it is said to be in consolidation, or in range. To recognize a consolidating market we draw either a triangle or a rectangle around the market price action, encapsulating the highs and the lows in clean straight lines (also known as a channel).
Ranging markets give us the opportunity to trade the breakout, which is the tendency of the market to switch into trend high gear the moment it moves out of the consolidation zone.
Trading these breakouts comes with a pitfall (as most things do): the fake-out. Fake-outs happen when the market appears to be breaking out of consolidation only to return to its comfort zone, the same consolidation box it was just breaking out of a candlestick or two ago.
To avoid this we wait for the retest, sometimes referred to as the last kiss. This procedure takes into account the market’s tendency to fake-out and eliminates the threat by waiting for the market to retest the consolidation zone and close below it again (for bearish breakouts) or back above it (for bullish ones).
Below is an example of how to trade the breakout retest:
Seen above is a fake-out where the market immediately pops back into the consolidation triangle. Later on we see a tentative breakout candle but we don’t trade yet. We wait. The market moves back towards the consolidation zone, touches it with a wick, but closes below it.
This is our signal. We put a sell stop at the lowest price of the retest candle and ride the breakout trade.
Once we see the market lose momentum we pull out, take profits, and enjoy the 100 pips we just made.
Stop loss is generally set just inside the consolidation zone. If the market moves back into the zone we know the breakout was an extra sneaky fake-out and we walk away from the trade. Because stops are so tight, breakout trades like this one are extremely safe and because we’re waiting for that retest and confirmation we can be extra sure that the market really is ready to trend.
All we need to do is ride the wave.