How to Trade The Break & Retest
11:59, 20 September 2023
Welcome to part 4 of our 7 Power Patterns series in which we teach you how to trade some of the most powerful price patterns which occur on any timeframe in every market.
In this week's instalment, we delve into the Break & Retest pattern—a strategic approach to navigating breakout trades. If you've wrestled with the frustration of false breakouts, incorporating this pattern into your trading toolkit may help you overcome this challenge and put you on the path to becoming a more confident and consistent trader.
We’ll teach you:
- How to identify and anticipate the pattern
- The underlying reasons that make the Break & Retest pattern such a valuable asset
- Three simple rules that can significantly enhance the pattern's effectiveness
I. Understanding the Break & Retest:
In essence, the Break & Retest pattern involves entering the market during the initial pullback following a breakout.
The pattern employs a three-step approach to validate the breakout signal. It relies on a fundamental tenet of price action trading: when resistance is effectively breached, it tends to transition into a supportive platform for the development of uptrends, while conversely, when a support level is convincingly broken, it typically transforms into resistance within markets trending lower.
Let’s run through the three steps in detail:
- The breakout: This is the initial movement where the price breaches a significant support or resistance level. It's essential to look for signs of genuine momentum and increased trading volume during this phase to validate the breakout.
- The retest: Following the breakout, the price retraces back to the level it previously broke through.
- The reversal: This is price action confirmation that broken resistance has turned into support (in the case of a bullish breakout) or broken support has turned into resistance if the (in the case of a bearish breakout). The confirmation comes in the form of a reversal candle. Typical reversal candles are long-tailed hammer or pin-bar candles, but they can also be engulfing candles or multi-candle reversal patterns.
The bullish Break & Retest:
The bearish Break & Retest:
Identifying and anticipating: The crucial first step in trading the Break & Retest pattern is to identify significant support and resistance areas on the price chart. Once these levels are recognised, traders should anticipate the pattern's development. Utilising price alerts can prove highly beneficial in this process, as they notify traders when the market is breaking out from these key levels. Additionally, setting alerts for the market's retest of the broken support or resistance level is equally valuable.
Entry points: Central to entering this pattern is the reversal formation observed during the retest of the broken support or resistance zone. An entry order may be strategically placed just above the high of the reversal candle (see bullish scenario) or below the low of the reversal candle (see bearish scenario).
Stop-loss placement: For risk management, positioning a stop loss is imperative. In a bullish scenario, a stop can be placed at a level below both the low of the reversal pattern and below the broken resistance level.
Price targets: Traders have the choice of setting a price target relative to market structure (the next key level or support or resistance) or a price target relative to risk. A price target twice the size of your risk is reasonable if you’re trading in-line with the dominant trend.
III. Why the Break & Retest pattern is so useful
Breakouts from key levels tend to be fast and volatile, making for a high-stress trading environment.
The Break & Retest pattern is so useful because it really helps to take the stress out of trading breakouts. It provides traders with a structured approach for confirming the authenticity of breakout signals while simultaneously reducing the associated risks of false breakouts.
It's important to acknowledge that not all breakouts will result in a pullback and retest of the breakout zone. However, over a large data set, traders who are patient enough to sit on their hands and wait for the first pullback will be less likely to be caught out by fakeouts and better positioned to manage their risk.
IV. Three simple rules to increase the patterns effectiveness:
Rule 1:The trend is your friend
It’s an old trading cliché, but when it comes to trading the Break & Retest pattern, the trend really is your friend. This is because the Break & Retest pattern fundamentally functions as a pullback pattern, and pullbacks tend to exhibit greater success within well-established trends.
Rule 2:The pullback should have less momentum than the breakout
The thrust of the breakout move should be steeper and have more momentum and volume than the pullback phase. A pullback that is just as steep as the breakout phase would be indicative of a failed breakout.
Rule 3:The retest should not linger
Optimal Break & Retest setups exhibit a resumption of breakout momentum shortly after the retest.. We do not want to see the market linger near the broken resistance (or support) level.
V. Managing risks and pitfalls:
Risk Management: Implement proper risk management techniques, such as position sizing, checking the economic calendar, and diversifying your trading portfolio. This helps protect against unexpected market movements and potential losses.
Additional Analysis: Don't rely solely on the Break & Retest pattern for trading decisions. Supplement your analysis with fundamental factors and market sentiment to gain a comprehensive view of the market.