The Shakeout Before the Breakout!
- Trader Stewie
- 2 days ago
- 6 min read
Updated: 10 minutes ago
Hi Folks! In this educational post we will cover what I like to call the "shakeout before the breakout!", basically a false technical "breakout", a common occurrence that I'm sure every trader is quite familiar with. Newer traders tend to get caught up in these types of shakeouts early on in their career and this is the primary reason why I've created this guide. I hope this guide can add value and accelerate the learning curve when it comes to navigating these trading patterns and hopefully save some frustration along the way!
False breakouts, also referred to as failed breakouts or bull or bear traps are a common phenomena where price appears to break a key support or resistance level but quickly reverses direction, potentially trapping traders who attempted to chase the breakout. Here's an in depth look at what they are, why they happen, and how to spot them:
What Is a False Breakout?
A false breakout occurs when a stock's price temporarily moves beyond a key technical level like horizontal support/resistance, a trendline, or a technical chart pattern breakout (Bull flag, falling wedge, pennant pattern) but fails to hold above (or below) that level. The price then quickly reverses, catching breakout traders offside, often with a less then desirable entry price and a wider range of potential downside risk.
Real World Conditions and Examples:
False Bullish Breakout
Price breaks above resistance, triggers buy orders, then quickly falls back below resistance.
$NBIS is a fantastic recent example of a stock that makes technical "breakouts" that often turn into shakeout moves before continuation of the pattern.
The first example is the price action in May. The stock made a breakout move from May 12th into May 20th. From there it traded sideways but not before attempting a breakout move on May 29th. This was followed by a shakeout candle the same day where the stock traded down for 3 days in a row, then creating a false breakdown move on June 2nd. From there the stock reversed and resolved higher. Trading up +72% higher from the low to the high June 2nd through June 9th.
The second example is the current price action observed from June 23rd to current date. The stock built a bullish pennant technical pattern from June 9th in June 23rd. Technically speaking June 23rd could qualify as a false breakdown day where the stock broke the technically pennant pattern but managed to close back up in the pennant pattern range. From there the stock broke out on June 24th but made a "shakeout" candle the very next day.
On June 30th the stock tried to break out again but was met with another shakeout candle on July 1st. Overall this is healthy consolidation action for a potential continuation move higher but its also a fantastic example of a stock that is very good at shaking traders out before the bigger move takes place.
$NBIS is a perfect example of a stock where anticipating the breakout before the breakout reduces downside risk and increases reward!
Lets move on to false bearish breakdowns.
False Bearish Breakdown
Price drops below support, triggers sell/short orders, then quickly bounces back above support.
$TSLA has been a recent example of this phenomena where the stock makes deep reversal below support trigger sell stops and short orders and then quickly trading back above the level of support just a few short days later. This moves range from 10% - 15%+ in a very short term time period. Double that range from the loss of support down and then the gain required to recapture support in a very short term timeframe. These are textbook examples of traders getting caught wildly offside both on the long and short side of a move.
Why Do False Breakouts Happen?
Market Maker Manipulation and/or Liquidity Grabs
Institutional traders and algorithms may intentionally push prices past obvious price levels to trigger stop losses or breakout entries, then reverse the move to collect liquidity.
Low Volume Breakouts
Breakouts without strong volume can imply weak conviction and are more prone to failure.
Overcrowded Trades
This is what I like to call the "too many eyes syndrome". This is where many traders are "seeing" the same thing in the market or on a particular stock and say things like "Its gotta breakout this time! Easily 10% higher next week, this is a textbook setup!" They then proceed to all pile in at the same price
News, Headlines and Data Point Whipsaws
Earnings reports, Fed comments, or economic data can cause quick spikes or drops that don't hold. Traders have a tendency to chase positive data points. A by-product of Fear Of Missing Out (FOMO)
How to Spot and Avoid False Breakouts / Break Downs
Wait for a Retest or Undercut of the Breakout Level
Wait for price to break the level, pull back to retest it, and hold before entering. A breakout and retest pattern is one of my go to patterns. It helps curb FOMO and allows for a stronger entry in relation to risk to reward.
Use Multiple Timeframes
A breakout on the 5 minute timeframe chart may look like noise on the daily. Use multiple timeframes to help spot high probability breakouts. A strong breakout will show itself on multiple timeframes. Ask yourself questions like "does the 60 minute breakout correspond with a breakout on a daily timeframe?
Check for Negative Divergences
RSI divergences, MACD divergences, or volume divergence (price goes up, momentum weakens, volume fades) may signal a false move.
Observe Candlestick Clues
Long wicked, topping tail type rejection candles near breakout zones can hint at rejection or exhaustion. This can all hint at short term overbought conditions as well.
Reference Overbought and Oversold Indicators
Occasionally a stock may reach a technical breakout zone or a major pivot but its technical overbought or oversold in that spot. In this case you wait for the overbought or oversold condition to fade through consolidation and then proceed with a breakout
Use your knowledge and skill to spot these "Shakeouts before the breakouts" trades here:
In this first example $MSTR made a "shakeout before the breakout" on July 1st. Quickly reversing +10% higher the next day and trying to follow through the day after.
In the second example $AMD Made a classic failed initial breakout over a 3 day period followed by a reversal back higher the next day (Mid June reference point).
The last one $CRWD. I actually tweeted about this setup on June 4th. It Looked like a failed breakout after it gapped down on earnings but the stock printed a "hollow" candle off the 20 day EMA. Marking the pivot/swing lows and start of a new leg higher.
Now knowing all of this, should I trade breakouts?
Yes, strong stocks are not just strong by random chance. Strong, high performing stocks are there for a reason. The best trades often come from the strongest stocks. Chasing these breakouts often isn't the answer you want to anticipate a breakout. Anticipating a breakout requires careful observation and monitoring of a setup over multiple days or even weeks. You want to observe key levels of support, resistance and observe how the stock trades overtime. Paying attention to timeframes and making note of the average true range of the stock will help you set your trading plan in place!
With this information you can plan your entry, set reasonable targets, stop losses and have proper expectations about how the stock trades. Chasing a breakout doesn't allow for this because you're just piling in with the crowd with no real plan. Your entry is less than ideal and the risk profile of the trade is often much greater then if you were to have just waited for a proper setup.
I've written an entire series on anticipating breakouts and reversal which can be found at these links here:
If trading breakouts and reversals fits your trading style check out my strategy building guide
I hope this guide on shakeouts before the breakout will be a value added tool to your trading repertoire. Keeping it simple, identifying what you're good at and improving on that should be your number one focus when it comes to building your strengths as a trader!
Cheers and Happy Trading!
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