A failed break occurs when a price moves through an identified level of support or resistance but does not have enough momentum to maintain its direction. Since the validity of the breakout is compromised and the profit potential significantly decreases, many traders close their positions.
A failed break is also commonly referred to as a "false breakout."
Failed breaks can lead to significant losses and are a key factor for consideration when a trader chooses to bet on a breakout. Breakouts commonly occur at designated resistance and support trendlines identified from either an envelope channel or a standard channel formation.
Support and resistant zones drawn from channel patterns can be highly sensitive areas for a security’s supply, demand and price volatility. Generally traders will look to these zones as areas for high profit potential. In a support or resistance zone, traders can seek to benefit from either a reversal or breakout. A breakout scenario is typically less common than a reversal since prices typically follow price trends that keep them trading within resistance and support boundaries over the short term.
A breakout can provide an opportunity to continue profiting from a trader’s current trading regime without drastically changing the course of their trading plans as needed for a reversal. However, just because a price breaks through a designated support or resistance line and shows an initial breakout does not always mean that the momentum will continue to carry it in a breakout direction. In some scenarios a price might see a throwback after breaking through its resistance or a pullback after breaking through support.
Throwbacks and pullbacks can be one of the first signs of a failed break. A throwback or pullback can be seen when a pattern retraces toward its resistance or support level. Retracement can often be common and may cause many traders to close out their positions due to reduced confidence. Thus, the confidence in a breakout can be very important to gauge. In this scenario, volume, demand and supply will be key factors that either support further strength for the breakout or cause retracement.
If a security does not see strong volume and substantial moves supporting the breakout, many traders will not take on further risk and close their positions. Generally while traders typically focus on technical patterns, a breakout scenario can also require some fundamental research. A price can often easily break through its resistance or support but if there is no fundamental evidence helping it to trend in the breakout direction many traders will close their positions.
Traders typically follow the 2% Rule for each investment opportunity to manage risk. The 2% Rule can be especially helpful for allowing a trader to begin trading into a reversal or breakout. This allows them to seek profit from a potential trading opportunity but also to setup a tiered investing schedule that can gradually invest as a trend gets stronger. Tiered investing schedules are generally known as grid trading and allow a trader to increase their investment with the development of a trend. Grid trading strategies can also allow an investor to stop further investment in the case of a failed break.