Breakout trading can be highly profitable. But the problem is this, it is impossible to tell whether the breakout will succeed or fail. So, how to trade breakouts when you are not sure about its success? Using Fib Projection Levels can help you trade breakouts profitably and reduce your loss in case the breakout fails.
When you spot the breakout candle, enter the market with half of your trade size. If the price continues in your favor as you had anticipated add 1/4th of the trade size at 138.2% of the initial move. And if the momentum continues in the direction that you had wanted and anticipated, add the final 1/4th of the trade size at 162.8% of the move.
Let's use an example to make this Fibonacci Breakout Trading Strategy clear. Suppose, you trade the lucrative EURUSD pair. You spot the breakout candle that is 100 pips in length with the high at 1.2300. You plan to trade this anticipated breakout with one standard lot. You can also trade with two or more lots. The strategy will work as long as you take care of the ratios when entering the position size.
You will enter the market at 1.2300 with 50,000 units or 1/2 lot. Place the stop loss at the 38.2% Fib Retracement Level in case the price retraces itself. This comes to be 1.2260. If the price retraces itself, you will be out of the trade. But since you have committed only 1/2 lot, you will only lose 20 pips.
If the price continues to trend in the direction favoring you, you will add 1/4 lot (25,000 units) more at 1.2338 level. This comes to be equal to 138.2% Fibonacci Projection Level. Your average price comes out to be 1.2312. You can now tighten the stop to 1.2298 level. You net loss in case of price making the retracement is 20 pips.
Add the final 25,000 units or 1/4 lot at 162.8% Fibonacci Projection Level. Your average cost now stands at 1.2325. Take profit at 1.2400. Your reward will be 75 pips and risk will be 25 pips, giving you an excellent risk to reward ratio of 1:3. You can use a trailing stop after you commit your last 1/4 lot to continue in the trade and take as much profit as possible as long as the price move continues.
So, by gradually increasing your position size, you have reduced risk while at the same time confirmed the breakout.
Breakouts tend to fail a lot with the price action retracing itself. Let's discuss the second situation in this article, where the breakout fails and the price action retraces itself. Can we still use Fibonacci Levels in trading a failed breakout. Sure, we can. We will be using Fib Retracement Levels to gradually enter the market this time. Once again, suppose we are trading one standard lot (100,000 units) of EURUSD currency pair. The price rises from 1.2200 to 1.2300 that is 100 pips as before in the last article. But this time, we are not sure about the breakout continuing so we take a more conservative approach.
You enter the market with 1/4 lot (25,000 units) at 1.2300 just like before. If the prices continue to rise just like before, you can still profit from that move by gradually adding to the partial position to target the exit of 1.2400. Now, suppose the price doesn't rise.
Instead, soon you find the price to be at 1.2262 which comes out to be the 38.2% Fib retracement level. You enter the market again at this 38.2% Fibonacci Retracement Level with an additional ¼ lot (25,000 units). Your cost now reduces to 1.2281.
Now, there can be two situations. Either the price bounces off from this Fib Support Level and starts to rise again. In such a case, you can again profit from your 1.2400 target with a better price of 1.2281 instead of 1.2300.
But let's assume, this does not happen and the retracement continues. When it reaches the 61.8% Fib Retracement Level, you again enter the market with an additional ½ lot (50,000) units. Your cost of entry now declines to 1.2259 from 1.2300. If the prices simply rallies back from this point back to your original price level, you will still be profitable.
Use the 76.1% Fibonacci Retracement Level to put the protective stop for the whole trade at 1.2220 as you think that the retracement will continue. Your risk is now only 39 pips.
Now, if the price action again reverses and starts rising, you can take profit favorably at 1.2338. This is the 138.2% Fib Projection Level. The risk for this trade is 39 points and the reward is 79 points giving you an excellent risk to reward ratio of 1:2. You can even use a trailing stop once the price starts rising to continue in the trade as long as possible.
These demonstrate that by using Fib Levels as flexible support and resistance zones, you can manage your trades in whatever direction the market starts moving. These Fib Levels can help you as a trader to better manage positions by adjusting your position to the market action. What you need to do is to practice these strategies on your demo account and see how well they work before trading live with them.