There is one signal that tells you a LOT about the future…
And most traders completely ignore this signal.
You see, most folks are focusing too much on either when to enter a market, or when to exit a trade that is already in profit.
As a result, they don’t see the most obvious signal that tells them: “Hey, this trade probably won’t work out. So let’s reduce our risk and get the heck out of this trade NOW!”.
What is this signal? Take a look at this chart:
The signal that you see on this chart – and is very powerful – is called a false breakout.
A false breakout occurs when price breaks through a key level – usually a previous high or low, or a technical level – and then immediately reverses direction and goes back to its original level.
In the above example, we see Home Depot (HD) breaking through and closing above a key resistance level at 137, and then a day later reversing direction and closing back below it again.
Therefore, if you went long at the original breakout, it is safer to EXIT the long trade immediately after the false breakout signal occurs – i.e. after the price goes back below the breakout point.
Here’s another example of this on the British Pound (GBPUSD):
The above example shows the GBPUSD breaking and closing above both the trendline resistance and previous high, only for the price to quickly reverse direction and go back below the breakout point.
Again, the best thing to do in such a situation is to immediately cut losses and exit the long trade.
False breakouts can happen in any direction, both long and short. So a false breakout of a support level is a useful signal to exit any short positions.
I consider the false breakout to be a very useful signal – and the signal usually shows when a market is about to do the opposite of what you had originally expected.
For example, a false breakout of a resistance level is typically a bearish signal – and vice versa for false breakouts of support.
Alessio Rastani is a stock market trader at www.leadingtrader.com