Trading the London breakout trading strategy
The London breakout trading strategy (also know as the London daybreak strategy) is one of the simplest trading strategies that you can use. This strategy makes use of the increased volume that you will see during the start of the London trading session.
Forex traders know that the forex markets are categorized into three main trading time zones. The Tokyo session, the London session and the New York session. The first hour of trading is when you will see a lot of activity.
The trading volumes also increase greatly due to the overlap of the Tokyo session’s close and the open of the London trading session. The chart below shows the various trading time zones.
Figure 1: Asian and London Trading session overlap
As you can see, there is an overlap of the Asian and the European trading session. This combined activity makes for a powerful time to trade.
With the London breakout trading strategy, you are able to take advantage of the increased volatility in the markets. An advantage of using this trading strategy is that by spending just a few hours a day, you can build a consistent trading income.
Of course, one should bear in mind that the London breakout trading strategy is not always successful. Besides the technical aspects which this strategy focuses on, you should also be paying attention to the fundamental news that comes during the time.
Still, with increased volatility, the London breakout trading strategy is a quite a valuable trading strategy that is worth exploring at the very least. One of the advantages with this trading strategy is that you can also customize it the way to you want.
In the London breakout trading strategy, as the name suggests, we only look at trading the breakout from the Asian session during the London trading session. But you can also combine different indicators and build your own trading system.
The main point of this trading strategy is that you need to focus on the short term aspects of the price movements that comes with this method of trading. This trading strategy is particularly suited for traders who trade intraday.
Therefore, in a way, the costs are also less because you don’t have to keep your positions open overnight and neither is there any worry of keeping the risk on the table. By mid-day you would be done with your trading.
By paying close attention to the risk management and also being a bit self disciplined, you can turn this simply trading strategy into an effective day trading system.
Let’s take a look in detail about the London breakout trading strategy and how can use this method to generate profits in the forex markets.
The London breakout trading strategy explained
As the name explains, the London breakout trading strategy builds upon the increased activity during the first hour of trading.
Obviously, the chart time frame we use are one hour charts. We also make use of candlestick charts because it allows the trader to understand the market sentiment to also reach the candlestick charts.
While this is not a requirement, having an understanding of the candlestick chart patterns, especially those associated with breakouts such as engulfing candlestick patterns, dojis and other such patterns can be very beneficial.
In terms of the currency pairs that one can trade, it is obviously the GBPUSD. But you could also look at some cross currency pairs such as the GBPJPY for example. The GBPJPY currency pair is known for its volatility.
This creates a lot of trading opportunities for the trader. Furthermore, because the London breakout trading strategy focuses on the Asian the London session, it makes sense to also look at the GBPJPY currency pair when using this method.
In the remainder of this article, we make use of a GMT+2 or GMT+3 (daylight savings time) broker.
The London trading session starts at 7AM GMT. Therefore, the time period between 7AM and 8AM is when you should be ready to trade the markets.
The chart below shows how you would set up your charts. The vertical blue dotted lines are the day separators, showing the one full day’s trading activity. The red vertical lines are the ones that denote the 7AM GMT candlestick session.
Figure 2: London breakout trading strategy set up
If you look closely, you will see that price action during the Asian session is quite range bound. Prices don’t make any big moves during this period. This is often the case most of the time, unless there are some big news releases that occurs during the Asian session.
After you identify the sessions, the next step is to plot horizontal lines to establish the range from the Asian session. After the stat of the London session, you will then wait for price to breakout from this range.
You will then take a position in the direction of the breakout.
The next chart shows such examples. Out of the three opportunities, we can see that the breakout from the two opportunities gave some good trading profits.
Figure 3: London breakout trading strategy system
You might be wondering now as to what the risk and reward set up is and how do you trade the breakouts.
For one, the risk should be no more than one percent of your trading capital. The reward can be set to two times the risk. This should suffice, but with active trade management, you can quickly move your trades to break even when price moves a significant way in the direction of your trade.
To begin with, traders must observe the price action during the Asian trading session. Then, plot the highs and lows that were made during the Asian session. Following this, you can then wait for price to breakout from the range.
Stops are placed a few pips above the high of the Asian session if you are trading a short position or a few pips below the lows of the Asian session if you are trading long.
Based on the risk set up, you can then set the trades for a 1:2 reward set up to achieve the best results for your trading.
Improving the London breakout trading system
As mentioned earlier, the London breakout trading system is an open system, meaning that you can use different indicators or methods to improve this simple trading system.
Some traders prefer to use moving averages and trade in the direction of the trend. However, one of the drawbacks of this method is that the trend you are looking at can be subjective.
A downtrend on a H1 time frame could be a retracement when you look at the same price chart on a four hour or daily chart time frame. It could very well be that the ranging price action is forming close to the end of the correction.
So, this makes one wonder how to trade the breakouts more successfully.
One way to make the London breakout trading strategy more effective is to wait for a retracement. This is a more efficient way to trade the London breakout strategy. The only exception is that it requires you to wait until the retracement occurs which can happen anytime during the course of the day.
This method also slightly deviates from the regular London breakout trading system. There will be times when you will have no trade to make.
The next chart shows one such example.
Figure 4: The London breakout trading method (improved)
Here, we wait for price to breakout from the range and then close outside the range. Once this happens, we place a pending limit order at the breakout price with stops at the nearest pivot high or low and then set the initial target to the previous candlestick’s low after the initial breakout.
The second portion of the trade can be left open and closed by the end of the day.
A main thing to remember when trading the London breakout trading strategy is that it is not just a breakout trading system. You also need to focus on the prevailing trends. The term breakout is said in the short term perspective (the few hours of the Asian trading session close and opening hours of the London trading session).
Therefore, if you see that the major trend is up and you want to trade the London breakout trading strategy, then you should be trading in the direction of the trend. Sometimes you might come across price action where the breakout moves in the wrong direction.
If such moves are in the opposite direction the major trend, then it is best to stay on the sidelines and wait for a more valid trading signal from the breakout method.
The next chart below shows the London breakout trading system using two exponential moving averages. In this example, we look at the trends within the 1-hour time frame and trade based off the signals.
Figure 5: London breakout trading system with EMA’s
In the EMA method of trading the London breakout system, we can get an additional filter, the EMA’s themselves.
The first example on the left side of the chart shows the EMA’s giving a bullish signal. The EMA’s are also sloping upward indicating a strong bullish trend. Trading the London breakout trading system to the upside here can greatly increase the profit potential.
Moving the next two sessions, you can see how the EMA’s turn flat. During these two sessions, prices continued to move in a range albeit being rather choppy. Without the EMA’s, you would perhaps be looking to trade these sessions as well.
Finally, on the right side, we have a short position. Here too, the EMA’s are sloping downward and following the bearish signal triggered by the EMA’s, we take the short position following the downside breakout from the London breakout strategy.
Three things to know about the London trading session
It is not just understanding the trading system but also in knowing the fundamentals behind this system. Here are three things you should know about the London trading system.
The London trading system is fast and active. Contrary to popular opinion, London is a major FX trading hub and is even bigger than that of New York. Therefore, when the London trading session opens, you can see a lot of interbank market activity.
The London trading system is volatile because that is when a lot of trading activity takes place. As London opens, investors get to react on the overnight news from the late U.S. trading session.
For example, activity is significantly higher after the FOMC meeting. The Fed meeting usually takes place around 6PM GMT. By this time, the London markets are already closed. Therefore, traders adjust their positions the first thing in the morning the next day.
The overlap of the Asian and London sessions can be volatile. This is because Asian traders tend to wind down their trading while London is just waking up and reacting to the overnight news.
Between the adjustments, you will find that London traders will be reacting to the overnight news, while in Asia, the markets already adjusted to the news. Thus, there will be a lot of volatility during this period.
In fact, if you take a look at the average true range indicator on a smaller time frame, you will see that the ATR tends to spike during this overlapping period.
The combination of these two time zones is also witnessed when there are major news releases coming out of Tokyo. For example, the Bank of Japan meetings are held during the Asian trading session and comes in just an hour before London opens.
Therefore, on one hand you have the Asian markets already trading and looking to close down the day, while another market, the London market is opening up to a new trading day.
Increased liquidity. While London is a big trading hub for FX, Tokyo and some parts in Asian such as Hong Kong are major trading hubs for the Asian currencies. Therefore, liquidity is quite high during the initial periods of trading.
But when it comes to the final closing hours, it is only the Tokyo session that is active and therefore liquidity tends to drop off but is made up by the opening session from London.
What are the best currency pairs to trade with the London breakout system?
As mentioned earlier, the most ideal currency pairs to trade the London breakout system is the GBPUSD and the GBPJPY. But your choices are not just limited to this. You can also trade other major currency pairs such as the EURUSD, USDCHF too.
Traders should not get too caught up with which currency pair to trade. When we mention the London trading session it doesn’t mean that only the GBP is the most actively traded currency. Likewise, when we mention the Asian trading session, it doesn’t mean that it is only the JPY currency.
A lot of other currencies also experience a lot of volatility during the overlap of these two trading sessions. Therefore, traders should firstly pick a few currency pairs and see how they behave during this overlap period.
Based on this and depending on the trader’s familiarity with the currency pair they can then narrow down to trading one or two currency pairs during this time period.
What are the advantages of trading the London breakout trading strategy?
The main advantage of trading the London breakout trading strategy is that it is very simple. There is no complicated use of multiple indicators. The risk and reward ratio of 1:2 means that you can make consistent profits using this trading system.
You get a lot of time to prepare your charts for the next day. Once the trade has reached the day’s profits, you do not need to stay glued to your chart and wait for other trading opportunities.
As mentioned, when you stick to one or two currency pairs using the London breakout trading system you can easily make decent profits on a daily basis.
Because the system is so simple you also do not need any specialized trading indicators or charting platforms. You can also download a copy of the London breakout trading system indicator which will automatically plot the time zones for you.
But in view of keeping things simple, you can simply make a note about what time London trading session starts in your local time zone and prepare yourself according.
This trading system is ideally suited for intraday traders and with some discipline you can make regular profits with this method of trading.
What are the disadvantages of trading the London breakout trading strategy?
The London breakout trading system is not a fool proof system. So, it too is susceptible to trading losses every now and then. All trading systems are unique and what works for one trader might not be the same case when used by another trader.
Therefore, it is recommended that you first trade the London breakout trading system on a demo trading account. Only after you have traded it for a considerable period of time should you think about utilizing this system with real money.
Sometimes, volatility during the period can be very strong and can lead to choppy markets. Because you are trading on the one hour chart time frame, you should also pay attention to the spreads.
If you are trading with a variable spreads broker, then you should pay attention to the spreads because they can widen during the first few minutes of the London trading session. This is not an abnormality, but how the markets work when a trading session opens.
There are some days when the economic calendar is packed with a lot of information starting from the Asian session. During such times, the markets can get volatile and therefore it is best that you avoid trading such markets.
Having presented both the pros and cons of the trading with the London breakout trading system, we can conclude that overall, this is a simple way to trade the forex markets. Using just the time zones and the breakout, you are essentially riding the liquidity wave that comes when two markets overlap.
Table of Contents
- Trading the London breakout trading strategy
- The London breakout trading strategy explained
- Improving the London breakout trading system
- Three things to know about the London trading session
- What are the best currency pairs to trade with the London breakout system?
- What are the advantages of trading the London breakout trading strategy?
- What are the disadvantages of trading the London breakout trading strategy?