How do Breakout traders get trapped?

29 apr 2022

In the example above, note the following:

- Warning candles: Doji + Hammers + bearish candles indicating exhaustion and a lack of follow-up.
- A relatively higher volume on hammer & doji, which is never a good sign for a breakout because it indicates significant selling pressure.
- A bullish breakout must always be accompanied by a good follow-up, else it won't sustain. Bullish BO needs good bullish candles, NOT dojis.

Notice how a small wick (on the daily chart) looks like a clear liquidity hunt on lower time frames.


Underlying concepts:

1. The market was moving sideways and generating liquidity on both sides.
2. In general, when the market is ranging, different participants place orders with a different bias. Hence, there is liquidity on both sides.
3. For a bullish market, the price must form a series of higher highs and higher lows. Similarly, for a bearish market, the price must form a series of lower highs and lower lows.
4. Whenever the price reaches a resistance level, there are 2 types of traders that take positions:
- Those who short the level in anticipation of it acting as a resistance.
- Those who long early in anticipation of resistance being taken out.

5. The stop losses of these traders act as liquidity. A short position has a “buy order” as SL, whereas a long position has a “sell order” as SL.

6. In general, almost everyone is aware of how the retail participants place their stop losses. They are either:
- Above/below an important swing level such as a support, resistance, day high, day low, etc.
- Above/below a demand, supply candle.
- Above/below the candlestick pattern such as a shooting star, hammer, and doji.
- Above/below the charting pattern.

7. The market moves from one zone of liquidity to another.
8. As a retailer, you may not realize the importance of a small wick. The small wicks are more than enough to liquidate plenty of positions.

Psychology and Behind the scenes stuff:

1. When the price reached the resistance level, 2 types of traders started opening positions.
- Aggressive shorters who shorted in anticipation that the level will hold.
- Aggressive longers (those who don't wait for confirmation) who were waiting for the candle to close above the resistance.

2. Both of these traders opened their positions and placed their stop losses in the system.
3. The banks/institutions have fairly complex algorithms that can easily identify these positions.
4. The stops of these aggressive participants are taken out fairly easily and the market moves from one zone of liquidity to another.

Thanks for reading! Hope this was helpful. If you need a PDF of this post with all the charts and write-up, check out the signature section (under the post).

Disclaimer: This is NOT investment advice. This post is meant for learning purposes only. Invest your capital at your own risk.

Happy learning. Cheers!
Rajat Kumar Singh (johntradingwick)
Community Manager (India), TradingView