Spotting Fakeouts Before They Trap You

If you've ever taken a trade on a price breaking through a key level and then saw it immediately reverse after the fact on your entry when it hit your stop-loss, then you've experienced a fakeout. For traders, fakeouts can be painful to the pocket and disappointing. Fakeouts have all the characteristics of a real breakout, but in fact the tendency is a trap to shake you out of weak positions.

If you have the right tools and the mindset, you can begin to identify fakeout scenarios before they trap you, and perhaps even use them to your advantage.

In this article, we will discuss what fakeouts are, the reasons they happen, and methods you can take to identify them early on.

What Is A Fakeout?

Fakeout is short for "false breakout." A fakeout happens when price moves above or below a key support, resistance, or trendline level only to quickly return to the previous range. Traders entering on that breakout find themselves trapped in the hustle and bustle of the fakeout, which often leads to losing trades very quickly.

• Bullish Fakeout: The price will break above a resistance level that may have buyers wanting to go along, but will immediately fall back down after the breakout.

• Bearish Fakeout: The price will break below the support level that may have sellers wanting to short, but would then snap back up.

Fakeouts are very common whether in Forex, stocks, and dusker markets, especially with volatility spikes.

Why Do Fakeouts Happen?

Fakeouts don't just happen randomly, they usually represent the psychology of the market and liquidity dynamics:

1. Stop Hunting

Occasionally some large players in the market drive price above a key level to trigger stop-loss placement orders as a means of creating liquidity for their own breakout and position entering.

2. Low Volume Breakouts

Similarly, if the price moves above a resistance level, the breakout can lack conviction due to a lack of volume. Market Noise

During news releases or thin trading conditions, volatility can create random signals.

3. Premature Entries

Traders who rush into trades too quickly also contribute to the prevalence of fakeouts.

Spy on Fakeouts Before They Trap You

1. Volume Confirmation

Real breakouts usually come accompanied by volume. If price pushes through a level but volume is low, be cautious; it could be a trap.

2. Wait for Candle Closes

Don't jump in the moment price reaches or crosses a threshold. Wait for a candle to close clearly beyond support or resistance.

3. Watch for Retests

Most, if not all, good breakouts will retest the level that has been broken. If price fails the retest--there's a good chance that this was a fakeout.

4. Use Multiple Tickers

A breakout on a 15-minute chart might not mean anything if it doesn't align on the 1-hour or daily chart.

5. Check Market Context

Is the breakout in line with the overall trend? It's more likely to fail the opposite of the dominant trend.

Tools and Indicators to Help Identify Fakeouts

Bollinger Bands

If price pushes out the bands and quickly snaps back inside the bands, look out!

Relative Strength Index (RSI)

If the breakout effort direction isn't confirmed by RSI (i.e., price breaks higher, but RSI stays flat), the momentum is not strong.

(The Average True Range) ATR

ATR helps to identify volatility. Low volatility breakouts may be weak.

Moving Averages:

A breakout that fails to hold above/below any key moving average is usually a fakeout.

Fakeouts in Action

Fakeout Example 1: Resistance

The EUR/USD approaches resistance territory, at 1.1000. Price breaks above for a short moment and triggers buy orders, but the volume is weak. Shortly thereafter, in the next few candles, the price falls back into the range and traps any buyers above the resistance.

Fakeout Example 2: Support

The USD/JPY pushes below 140.00, pulling in a slew of sellers. However, instead of continuing lower, the price sharply reverses and rallies above support (140.00). Sellers get stopped out while contrarian buyers take a profit.

How to Protect Yourself Against Fakeouts

1. Exercise Patience

Do not enter a breakout immediately; search for confirmation, for example, candle closes or retests.

2. Use Smart Stops

Stops should generally be placed at levels that are not immediately obvious. Give them a little breathing room once the price is approaching likely "stop-hunt zones."

3. Risk Small

It is easy to over-risk position size, especially in volatile markets that can have fakeouts.

4. Use Technical and Fundamental Analysis

If a breakout occurs during a major news release, beware, it can simply be noise.

Turning Fakeouts into Opportunities

Some experienced traders will use fakeouts as signals themselves. For example:

- If price breaks the resistance but falls back down instead, a trader may short the market expecting the trapped buyers to help pull it lower.

- Conversely, if price fakes through support and reverses back up long, that could be smart contrarian trade.

This type of trading does not lend itself to many traders, but can be effective given discipline and order management.

Common Trader Mistakes with Fakeouts

- Chasing price: Entering rashly with no support or confirmation.

- Forgetting volume: Thinking every fakeout is a real break.

- Too much leverage and risk: Just one fake out can wipe out an account.

- Trading in a vacuum: Not considering broader market context or fundamentals.

Tips for Becoming More Confident Against Fakeouts

- Keep a fakeout journal. After a period of time, you will see some common themes emerge.

- Show Patience. The best trade may be no trade.

- Follow a good setup. Less is more.

- Understand fakeouts are part of the deal. No one expects to escape them entirely, it is simply part of minimizing their impact.

Conclusion

Fakeouts are the most challenging part of trading. They appear to invite traders in for a big move only to reverse back and make you angry suddenly. However, by recognizing some warning signs—low volume, poor close, and poor market context—you can establish some protection against them or use them to your advantage.

The key is Patience, confirmation, and sound risk management. Once you are capable of reacting to fakeouts, profit in trading and loss avoidance will way better year after year.