What it means
Traders watch levels where a price has repeatedly stalled, called resistance (a ceiling) or support (a floor). When the price breaks through such a level, many assume a new trend is starting and rush to buy or sell.
A fakeout happens when the move fails and the price returns to its previous range. Fakeouts occur for several reasons.
Large traders may push the price through a level to trigger stop orders, then reverse. In thin markets, a few trades can move prices temporarily, and sometimes news that seemed important turns out not to be.
The cost lands on those who entered late. A buyer who purchases at the break of resistance finds the price falling back below it and must either accept a loss or hold on and hope.
Stop-loss orders placed just beyond the level can be triggered, which adds to the losses. Traders try to reduce the risk of being fooled.
Some wait for the price to close beyond the level for a full day or week, some require higher trading volume to confirm the move, and others wait for a retest, where the price returns to the level and holds. No method is perfect, and each involves giving up a little of the early profit.
The idea applies beyond shares. Currency, commodity and cryptocurrency markets all show fakeouts, and the concept is useful when reading business charts such as a sales trend.
A single month above a target does not prove growth has changed if the next month falls back. For anyone managing risk, the practical lesson is to size positions so that a failed breakout is survivable.
Decide in advance where you will exit if the move fails, and calculate how much that exit will cost. This turns a fakeout from a shock into a known expense.
In practice
Real-world examples.
Example
A stock trader sees a share rise above its 52-week high and buys. By the close, the price is back below that level on low volume. She sells for a small loss and notes that the breakout lacked volume.
Example
A currency trader sells after a pair drops below a long-term support level. Within hours it returns above, triggering his stop. He decides next time to wait for a daily close below support.
Example
A company's finance director sees monthly sales exceed target for the first time in a year and considers raising the forecast. The next month falls back to the old level, and she realises that one strong month was a fakeout. She waits for three months of data before making a change.
Formula
Calculation
Loss on a failed trade = (entry price - stop price) x number of shares
Suppose a stock has been capped at $50 for months. A trader buys 2,000 shares at $50.50 after a breakout, with a stop-loss at $49.50. The breakout is a fakeout and the price drops to the stop. Loss = (50.50 - 49.50) x 2,000 = 1.00 x 2,000 = $2,000. With a $200,000 account, that loss equals 1% of capital, which is a sensible level of risk for a single trade.Case study
Seen in the real world.
Quarry Point Capital is an illustrative, fictional trading firm that tested a rule to buy any share that broke above its 3-month high. In a sample of 100 trades, 45 were genuine breakouts, and 55 reversed within three days.
The genuine ones averaged a gain of $1,500, and the failed ones averaged a loss of $700. Total = (45 x 1,500) - (55 x 700) = 67,500 - 38,500 = $29,000.
In this fictional story the firm added a volume filter that removed many of the failed trades, but also some winners. It decided that the stop-loss and position size mattered more than predicting which breakouts would succeed. The lesson is that a strategy can be profitable even with many fakeouts if losses are kept small. The risk manager added that the firm would review the rule each quarter, because market conditions change and a rule that worked in a trending year may struggle in a choppy one. She also reminded the traders that every trade should have an exit price written down before the order is placed.
Watch out
Common mistakes.
- Buying the very first tick above a level without any confirmation, such as volume or a closing price.
- Placing stop-loss orders exactly at obvious round numbers where fakeouts often happen.
- Risking too much on a single breakout, so that a failure causes serious damage.
Questions
People also ask.
What causes a fakeout?
Causes include stop-order hunting, thin trading, overreaction to news and large traders reversing positions.
How can I tell if a breakout is real?
There is no guarantee, but higher volume, a strong close beyond the level and a successful retest increase the odds.
Is a fakeout the same as a false breakout?
Yes, the terms are used interchangeably for a move beyond a level that quickly reverses.
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