Trading with the MT4 breakout indicator
Breakout trading is one of the two major ways that traders can trade. The other type of trading being the trend trading. Both these types of trading have the same common goal. However, the way the trades are taken depends on the market behavior.
As you might already know, prices move in a trend only 20 percent of the time. For the remaining 80 percent, price tends to move sideways. Therefore, one might argue that it is a better approach to trade the ranges or the sideways price action rather than trends.
But the risks of trading the breakouts are equally high. When you trade with a trend, prices burst out with momentum. Thus, they make little to no pullbacks. This means that traders who are positioned into the trend can reap huge profits.
Trend trading brings a distinctive advantage of being able to quickly cover the risks and move the trade to break even. This gives trend traders an undue advantage. Being able to trade risk free in the markets, is something of a luxury.
With breakout trading on the other hand, prices tend to move around, or chop around or whipsaw. At such times, the markets can lead a trader into believing that price will move in one direction, only to reverse course.
A sideways range happens due to the accumulation phase in the price of an instrument. When prices move aimlessly but within the confines of the range, they tend to accumulate more positions.
Once enough positions are accumulated around a price level, this leads to a surge in the price, which is nothing but a breakout. A breakout occurs as volume starts to build up. Typically, it is the momentum that starts to build up. Over the course, this momentum led breakout morphs into a trend.
If you can observe closely, traders who are positioned initially in the breakout phase tend to fare better when the trend emerges. They are adequately compensated for the risk that they take. Being early in a trend brings a lot of advantage for breakout traders.
It is not surprising then that traders, especially those who day trade can use the breakout trading method as a way to capture profits. Due to the momentum surge in prices, the trade can be closed out with a profit or a loss rather easily.
For years, traders have been looking at ways and means to find the perfect breakout trading strategy. Some use volatility bands such as the Bollinger bands to trade the breakouts which leads to the emergence of a trend. While others make use of boxes to define the horizontal price levels from which a breakout could occur.
There is no science in trading the breakouts. Most of the times, prices can tend to reverse the precious trend just as easily as they continue the trend as well. Therefore, it is important to understand breakouts in the context of the trend. This will help traders to position themselves before hand and prepare for the trend that could emerge.
How to trade breakouts?
Just like there is more than one way to bell a cat, there are different approaches to trading the breakouts. Regardless of what approach you use, there are some factors to consider which will determine the outcome of your breakout trade.
For starters, it is good to build a market context before planning to trade the breakout. Remember that a breakout is an accumulation phase. Unless the direction of the breakout is strongly established, it can be difficult to trade the direction of the breakout.
Quite often, traders lose money because they follow the price. Also known as a fakeout, this occurs when price tricks trader into believing that they will move in one direction, only to reverse course and trap those positions.
Eventually, what happens is that these weak positions are closed out, depending on the intensity of the reversal. These closing out of positions add to the momentum and leads to further increase in momentum of the breakout.
The most common way to trade the breakouts is to wait for a retest of the breakout level. However, there are some distinctive disadvantages here. Firstly, prices never retreat to the breakout level all the time. So, traders who wait for the pullback to the breakout level end up sitting on their hands. This means a lost opportunity in the markets.
Because the breakout emerges with such strong momentum, emotions can take over and the trader is convinced on the direction of the breakout. This is a perfect opportunity for price to reverse course and retreat to the breakout level. You can see that the trader is at a disadvantage here. Open positions are forced to close out, leading to losses.
Therefore, it is crucial to understand the breakouts in the context of the general market structure. The best way to do this is to understand the trends in the market. The first chart below gives an example of how the breakout indicator for MT4 is plotted alongside the trend (using moving averages).
The MT4 Breakout indicator – how to use it?
The MT4 breakout indicator is a rather simple indicator. Instead of you having to draw the breakout ranges, the indicator automatically plots the breakout boxes for you. You can define the time period for the indicator as well.
The general settings are for the breakout indicator to start from the first hour of trading. You can then set the final trading hour. Within this defined time frame, the breakout indicator plots the high and low of the period.
Installing the breakout indicator is quite simple. Download the file and install it into the indicators folder of your MT4 trading platform. Then open your trading terminal and refresh the indicator window. Once you see the breakout indicator in your list, you can drag/drop the indicator onto the chart of your choice.
Below is the configuration settings for the MT4 breakout indicator.
MT4 Configuration window – Breakout indicator
The above configuration window shows you the details on how you can customize the indicator’s setting. One of the downsides of the breakout indicator is that it is dependent on the time sessions.
This means that you cannot use the above breakout indicator to plot breakouts during various periods of the trend. Rather, this breakout indicator is used to plot the range during a trading session.
The customization also includes the ability to color code the indicator to make it more visually appealing.
Once the indicator is applied to the charts, this is how it looks like.
MT4 breakout indicator
As you can see in the above chart, we set the breakout indicator to start from the opening session of the day on the hourly chart. Following this, we also set the timeline for the indicator, depicted by the vertical line which marks the start of the next trading session.
As price breaks out from the confines of the time periods and the range, traders can trade the breakout according to their choice. The indicator can complement any trading system. In fact, you can build your own trading system based on the breakout indicator used above.
Breakout trading strategy using the MT4 breakout indicator
There are various strategies that one can use with the breakout indicator. However, it should be noted that the breakout indicator is ideal when using on the one-hour chart time frame.
If you switch to a higher time frame such as the four-hour period, chances are that the indicator will not work that well. You will have to increase the period settings. On the other hand, you could switch to a lower time frame chart such as the 15-minute or the 30-minute chart time frame.
In this section, we outline a rather simple way that you use the breakout indicator. We first apply the breakout indicator and also make use of a 20-period moving average (exponential). This will allow you to gauge the trend of the markets as well.
Once both the indicators are applied to the chart, this is how it would look.
MT4 Breakout strategy
In the above chart, we have included the 20-period exponential moving average and the breakout indicator. A simple way to trade this set up is to look at the breakout range from the previous day.
You can see that we have plotted a black horizontal line on the chart for the previous session (the second from the left). Following the low of this, we then wait for price to breach this level. Notice that at the same time, we expect price to be below the moving average.
After the breakout below the low, we wait for price to retrace back to this level. The next day, you can see that price breaks out lower and then promptly rallies to retest this level. On such a retest, we take short positions.
The stops are placed near the previous highs while the target is set to the next day’s lower range of the breakout. Once the trade is triggered and the price moves in your direction, it is ideal that you move your stops to break even.
You can see that the initial risk/reward set up is about 1:1. Therefore, it is essential that you move your risk to breakeven in order to avoid leaving risk on the table.
Observing the above chart, you can see that price eventually breaks down lower and test the previous low reaching the first target. You can leave part of the position open and trail your stops.
The trailing of the stops can be done by moving the stop loss to the previous -1 day’s high. This will ensure that you do not risk any further but also lock in some profits. This method is very easy to trade in the short term and when the trend is strong.
It might not work so well when the markets are ranging. In the next chart, we have an example of a long position that you can take applying the same method.
MT4 Breakout strategy – Long position example
In the above chart, you can see that we set our horizontal line to the previous day’s high. Following the breakout above this level, we see that price falls back to test the previous day’s high.
This triggers the entry to the trade. Once the trade is picked up, you will notice that price starts to move in the direction. We quickly move the position to break even and while the first target is picked up, we then trail the stops until the markets stop out the trade.
The breakout indicator as illustrated above is easy to work with. Besides using the moving average, you can also use technical oscillators or other indicators that can help you to trade better.
You could also experiment with using the Bollinger bands or other channel indicators for example and use it alongside the MT4 breakout indicator.
The MT4 breakout indicator – Conclusion
To conclude, the MT4 breakout indicator is a custom technical indicator that allows you to customize the settings. Its primary usage is to plot the ranges of the high and the low that are formed.
Depending on whether your broker is GMT or GMT+2 or GMT+3, you can customize the settings of the MT4 breakout indicator. After the boxes are set up, you can wait for price action to breakout from the range.
The breakout level will potentially give you trading opportunities. It is recommended that you do not use the MT4 breakout indicator in isolation as it could lead to false signals. Therefore, you should use this indicator alongside other technical indicators that can validate the price action for you.
This simple trading indicator is ideally used for short term trading only. It works best on time frames from 1-hour to lower. For day traders, this can be a useful tool as it shows them potential trading opportunities on an intraday basis.
Combing with other technical indicators, the breakout indicator allows you to capture the volatility led breakout that is common to such patterns in the market.