What Is a Failed Break?
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 some traders look to establish positions when a breakout occurs, in the breakout direction, they may opt to close those trades if the breakout fails.
Failed breaks may also signal traders to enter a trade in the opposite direction of the attempted breakout. Since the breakout attempt failed, the price could head the other direction.
A failed break is also commonly referred to as a "false breakout."
- A failed break is when the price of a security moves beyond a support or resistance level (breakout) but then reverses course moving back below resistance or above support.
- A failed break is different than a throwback. A throwback is a short-term retracement back to the breakout point.
- Some traders opt to trade breakouts. Other traders wait for failed breakouts, and then trade in that direction (against the breakout).
What Does a Failed Break Tell You?
A breakout is when the price moves through a support or resistance level and keeps moving in that direction. A failed breakout is when the price moves through a support resistance level, but then fails to continue moving in that direction and instead reverses course.
For example, assume the price of a stock has reached $100 several times in the past, but each time it is fallen after reaching it. This is a resistance level. If the price moves above $100, that is a breakout. If the price then falls back below $100, and keeps dropping, that is a false breakout. The breakout lost momentum and the price reversed.
A failed breakout reveals that there was not enough buying interest to keep pushing the price above resistance or below support.
After a failed breakout short-term traders may opt to exit their position if they were hoping for a breakout. The reason for the trade failed to deliver as expected.
Other traders may opt to trade in the failed breakout direction. In the example above, not only may they exit a long position after the price failed to hold above $100, but they may even go short if the price drops back below $100.
A failed breakout doesn't necessarily mean the price can't continue moving in the breakout direction shortly after. For example, the price may move above $100 to $103, drop back to $99, then rally to $104 then, drop back to $100. This type of choppy price action can result in losses for breakout trades as well as those waiting to trade the failed breakout.
Throwbacks After a Breakout
A throwback may cause some traders who entered in the breakout direction to close their positions due to reduced confidence. A throwback is not a failed breakout.
If there is significantly increased volume on a breakout, the likelihood of a false breakout developing decreases (but is not eliminated). However, a throwback may still occur. For example, the stock breaks above resistance at $100 and runs up to $105 on heavy volume. The price may decrease to $101 or even $100, and then continue moving higher. This is a throwback, not a false breakout.
If a security does not see strong volume and substantial price moves supporting the breakout direction, traders may close their positions because the chance of a false breakout increases. If there is strong volume and price movement following a breakout, savvy traders may use a throwback to add to their position in the breakout direction. If the breakout fails, they may choose to exit their positions.
Example of a Failed Break in a Stock
The daily Alphabet Inc. (GOOG) chart reveals a false breakout to the upside. The price moved above the prior high the day before earnings. The breakout even occurred on elevated volume.
Earnings were released the following day the price gapped lower. The upside breakout failed.
This example warns of the dangers of trading around earnings, since the price could gap significantly. Anyone who bought the breakout would have had to exit at a much lower price the following day.
The Difference Between a Failed Break and a Test
A test or retest is what could lead to a breakout or a failed break. A test is when the price moves back to a support or resistance level. On that test the price could break through the level (breakout), or it could break out and then fail.
Pros and Cons of Trading Breakouts and Failed Breaks
Many traders buy breakouts above resistance or sell or short breakouts below support. The logic is that the price may continue moving in that direction after the breakout occurs. Other traders watch for false breakouts, and then trade in the opposite direction of the breakout. This is because they believe that if the breakout failed, the price may continue moving back in the other direction.
Either method of trading isn't easy, and can result in frustration. Breakouts often have throwbacks or appear to have false breakouts. This may shake the confidence of the breakout trader, or cause them to lose money.
A failed breakout trader faces a similar problem. The price may initially fail to move in the breakout direction, but then may succeed a short time later.
Like any strategy, when the price moves cleanly and swiftly in the expected direction, profits seem easy. But much of the time price movements are choppy, filled with a mix of breakouts, throwbacks, and failed breaks. If opting to trade these strategies, let profits to run to capitalize on the trades that do work out, and if wrong, cut losses quickly.