How to Identify a Forex Breakout
The forex market, which is also known as the foreign exchange market, is one of the most liquid and widely traded financial markets. Changes in the market occur when one currency's value changes relative to another currency. This process can occur with tremendous force and momentum, generating what's called a breakout in a specific currency pair.
What is the Forex Market?
The forex markets are made up of currency pairs, which are the relative value of one country's currency to another country's currency. Prior to the 1970s, many major currencies were pegged to gold prices, and did not float freely with market sentiment.
What are the Securities in the Forex Markets?
The securities that are traded in the forex markets are currency pairs. A currency pair is one country’s currency movements relative to another country’s currency movements. An example of a currency pair is the Euro versus the US dollar. During the course of normal daily trading, the EUR/USD currency pair can fluctuate in value by nearly .5 percent. A currency pair contains a base currency and a counter currency. Major currency pairs are those that contain the US dollar as part of the security, while cross currency pairs are those that do not have the US dollar as part of the security that is traded. Currency pairs are traded in the cash market, as futures contracts, and exchange traded funds.
Support and Resistance
Support is an area of market consolidation in which buyers of a currency pair express demand by purchasing that security at a specific level. Downward momentum is halted at support levels as buyers attempt to move prices higher. Resistance is an area of market consolidation in which sellers provide supply, forcing prices lower. Upward momentum is mitigated at resistance levels as sellers attempt to move prices lower.
The forex market fluctuates with market sentiment on a daily basis. Investors who trade the forex markets use multiple strategies to predict the future direction of currency pairs. One of the most widely used strategies is a breakout strategy. A breakout strategy is one in which a currency pair moves above a resistance level or below a support level, and continues to move in the direction of the breakout. Many traders wait for the daily closing price to settle above resistance or below support to signal a breakout. For example, if resistance on the GBP/USD is 1.6600, and the price of GBP/USD closes the trading day at 1.6700, a breakout occurred. Generally, weekly closing prices above resistance or below support are considered a stronger measure of a breakout than a daily close, and are more likely to lead to a continuation of price action in the direction of the breakout.
David Becker is a finance writer and consultant in Great Neck, N.Y. With more than 20 years of experience in trading, he runs a consulting business that focuses on energy hedging and capital market analysis. Becker holds a B.A. in economics.