Trading the Euro Pound Wedge Breakout

12/10/2013 9:00 am EST

Focus: FOREX

Bullish breakouts have a tendency of returning to the area of the breakout before moving higher, so even if you missed out the first time, you could get another chance, says Gregory McLeod of DailyFX.com.

Forex traders use price patterns to anticipate when and where a breakout may happen. They also use price patterns to estimate potential profit if the pattern is valid as well as potential loss if the pattern fails. However, if one misses the initial breakout, forex traders can still trade these price patterns and find a low-risk entry sometimes better than catching the initial entry.

For example, take the EUR/GBP chart below and notice that it has been winding within a forex falling wedge pattern for over a month. At the beginning of November, the sellers were obviously in control pushing prices lower with wide-ranging bearish candles. However, toward the middle of November, bearish momentum starts to wane with sloppy overlapping waves. Bears were unable to make much progress below the 0.8300 area.

For sellers, time is money and capital can be better deployed in a faster and more lucrative trade. The combination of bear exits and breakout traders contribute to the two-day push higher from the falling wedge pattern. The move also confirms the pattern. So since the train has left the station, is there a way for those who are not aboard to get involved with less risk. The answer is “yes!”

EUR/GBP Falling Wedge

chart
Click to Enlarge

The Trade Setup
Breakouts have the tendency to retrace and return back to the area of the initial breakout. It is like those detective and police shows where the criminal always returns back to the scene of the crime only to be arrested by the awaiting officers. Price often returns to test support and we can use this tendency to our advantage by having a pending entry order near the breakout area and make our own “arrest.” In this case, the upper trend line of the falling wedge pattern coincides with the round number 0.8300.

Placing an entry order or “buy limit” at this point, traders will be able to enter the trade at a discount when compared to the breakout traders who may have been filled several pips higher. A stop can be placed at 0.8247 just below the 0.8251 December 2 swing low of the falling wedge pattern. Since the height of the pattern is 293 pips, a limit can be set at 0.8593. This EUR/GBP long trade has a potential 1:6 risk to reward.

Remember, there are no guarantees that the EUR/GBP will come back down to our level. In fact, if could continue to run higher to the measuring objective near 0.8600. In that case, we move on and look for another trade and not fret over the “fish” that got away! However, we have outlined a trading plan for getting into the trade on our terms at a discount with a limited predefined risk. It really pays to wait!

By Gregory McLeod, Trading Instructor, DailyFX.com

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