What it means
Traders often watch levels where prices have previously stalled, such as a recent high or a support line. A move through that level is read as a breakout, meaning the start of a new trend.
A head fake happens when the price pokes through the level, attracts buyers or sellers, and then reverses sharply back into its earlier range. Head fakes occur for several reasons.
Thin trading can let a small order push the price past a level, news can briefly excite the market and then fade, or large investors can trigger other people's stop-loss orders to buy at better prices. The result is the same: those who acted on the breakout are caught on the wrong side.
The cost can be larger than it looks. A trader who buys the breakout, is stopped out at a loss and then watches the price reverse again has paid a loss, trading costs and possibly the spread (the gap between buying and selling prices).
Repeated head fakes can quietly eat into returns, particularly for traders who use leverage, meaning borrowed money. Practical defences include waiting for confirmation, such as a close beyond the level instead of a brief intraday spike.
Traders also look for higher trading volume on the breakout, since a real move usually attracts more participation than a false one. Position sizing and stop-loss orders limit the damage when the signal turns out to be wrong.
A head fake is sometimes the basis of a deliberate strategy. Some traders wait for a failed breakout and then trade in the opposite direction, reasoning that those trapped on the wrong side will have to exit and push the price further.
That approach has its own risks, because the apparent failure can itself be a pause before the original move resumes.
In practice
Real-world examples.
Example
A retail investor buys a technology share the moment it trades through its all-time high, only to see it fall back below that level within the hour. The company had announced nothing new, and the breakout was driven by a small burst of buying.
Example
A commodities desk sees oil jump above a key price after a headline about supply cuts. Within a day the report is clarified, the price falls back, and traders who bought the breakout take losses while others sell into the spike.
Example
A foreign exchange trader notes that a currency pair has repeatedly failed at a resistance level. When it breaks out again on thin volume just before a holiday, she waits for a daily close before acting and avoids the fake move.
Formula
Calculation
Loss on a failed breakout = shares bought x (entry price - exit price) + trading costs
Suppose a share has been stuck below $50 for weeks. It breaks above, and a trader buys 500 shares at $50.40. The price reverses and her stop-loss order sells the shares at $49.00. Trading costs are $20 in total.
Step 1: Price loss per share = 50.40 - 49.00 = $1.40.
Step 2: Total price loss = 500 x 1.40 = $700.
Step 3: Add costs: 700 + 20 = $720.
If her account is $36,000, she has lost 720 / 36,000 = 2% on a single failed breakout, which is why many traders limit the risk on each trade to a small fixed percentage.Case study
Seen in the real world.
Silverbrook Partners is a fictional small trading firm that kept losing money on breakout trades. A review by its risk manager found that 11 of its last 20 breakout entries had reversed within two days, producing losses of about $3,200 each, while the winners averaged $4,000.
The firm changed its rules in this illustrative scenario. It required a daily close beyond the level and above-average volume before entering, and it cut position sizes by a third. Fewer trades were taken, but the proportion of failed breakouts dropped, and the firm's annual loss on such trades fell by about $18,000.
Watch out
Common mistakes.
- Buying the very first tick through a key level, when many breakouts fail until confirmed by a close or by higher volume.
- Moving the stop-loss further away after the price turns, which turns a small, planned loss into a large one.
- Assuming every failed breakout can be profitably traded in reverse, when the original move often resumes.
Questions
People also ask.
Why is it called a head fake?
The name borrows from sports such as basketball, where a player fakes with the head or shoulders to send the defender the wrong way.
Can a head fake happen in the opposite direction?
Yes; a false breakdown below support that reverses upward is also a head fake, and it can trap short sellers.
How can I reduce the chance of being caught?
Wait for confirmation, check trading volume, size positions modestly and use a stop-loss order set before you enter.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related