The "Breakout and Retest" Pullback: A Confirmation-Based Entry Strategy

Editor's Note: This is a guest post from a professional trader with over 15 years of experience in the markets. The views expressed are his own.

The "Breakout and Retest" Pullback: A Confirmation-Based Entry Strategy

In the world of trading, patience is a virtue that is often in short supply. Many traders are so eager to get into a trade that they jump the gun, entering on a breakout before it has been confirmed. This often leads to losses, as many breakouts fail. A more prudent and profitable approach is to wait for a breakout and retest. This confirmation-based entry strategy can help you to avoid false breakouts and enter the market with a higher degree of confidence.

The Edge: The Power of Confirmation

The edge of this strategy lies in the power of confirmation. A breakout is a significant event, but it is not a guaranteed signal of a new trend. A retest of the breakout level provides that confirmation. When the price breaks out of a consolidation range and then pulls back to test the breakout level as support, it is a strong sign that the buyers are in control and the new trend is likely to continue.

By waiting for a retest, we are essentially letting the market prove itself to us. We are not trying to predict what the market will do, but rather reacting to what it has already done. This is a more conservative and reliable approach to trading breakouts.

Entry Rules: A Step-by-Step Guide

Trading the breakout and retest strategy requires a step-by-step approach.

1. Identify a Consolidation Range: The first step is to identify a well-defined consolidation range, with a clear level of support and resistance.

2. Wait for a Breakout: Next, wait for a decisive breakout from the consolidation range. The breakout should be on high volume.

3. Wait for a Retest: After the breakout, do not chase the price. Instead, wait for the price to pull back and retest the breakout level. This level should now act as support.

4. Look for a Candlestick Reversal Pattern: As the price tests the breakout level, look for a bullish candlestick reversal pattern, such as a hammer, an engulfing pattern, or a doji. This is a sign that the buyers are stepping in and defending the breakout level.

5. Enter the Trade: The entry signal is a buy order placed above the high of the candlestick reversal pattern.

Exit Rules: A Plan for Taking Profits

Having a clear exit strategy is important for success.

• Profit Target: A logical profit target is the next level of resistance. This could be a previous swing high or a Fibonacci extension level. Another approach is to use a measured move objective, which is calculated by measuring the height of the consolidation range and projecting it from the breakout level.

• Stop Loss Placement: The stop loss should be placed below the low of the candlestick reversal pattern and the breakout level. This will protect you if the breakout fails and the price falls back into the consolidation range.

Risk and Money Management: The Foundation of Success

No matter how good the setup, risk management is non-negotiable.

• Position Sizing: Never risk more than 1-2% of your trading capital on a single trade.

• Risk/Reward Ratio: The breakout and retest strategy often provides an excellent risk/reward ratio. Aim for a ratio of at least 2:1.

A Word of Caution

The breakout and retest strategy is a high-probability setup, but it is not foolproof. There will be times when the retest fails and the price falls back into the consolidation range. This is why it is so important to use a stop loss on every trade. It is also important to be patient and wait for the setup to develop. Do not force trades that do not meet all of your entry criteria.

By incorporating the breakout and retest strategy into your trading, you can significantly improve your trading results. This confirmation-based entry technique, when traded with discipline and patience, can help you to avoid false breakouts and achieve consistent profitability in the markets.