How to tell a true break from a false break
A trader has few worse experiences than being on the wrong side of a false break in Bitcoin or any market. A skilled technical analyst knows how to recognise and evaluate support and resistance levels. But at what point has the level been broken? $1 through it? $100? How far does it have to go before you have the confidence to make the trade? Getting short (or long) on a break is an exposed and scary moment for traders.
The process may go like this: Testing and then breaking a support level, waiting as short a time as possible to feel confident the break is confirmed or taking the plunge by shorting the market and liquidating a long position. In volatile markets, there is thin trade as others recognise support giving way. Unfortunately, as soon as you've completed your short trade, the market occasionally turns fast and viciously in your face recovering and returning above the breakdown point. As a disciplined trader, you now know you are wrongly positioned and forced to cover painfully as the market moves back in the direction it was going in before the dreaded false break. Worse, you are scrambling to get long as the price confirms the support level has been held by moving higher.
Has this happened to you? It is humiliating and very frustrating. It can even fill you with self-doubt. No matter how good you are as a trader and technical analyst, false breaks are a fact of life. The best you can do is reduce the chances of the trade being another horror. This is true on Bitcoin, and indeed any market.
There is one sure way to avoid false breaks
There is a way you can never fall victim to false breaks - always place your stop so far away that you are sure the break is a true one. Then, given enough price movement and time, you will have the confidence to place a trade with the certainty a reversal will not stop you out. The problem is that by the time the price gets to the point you are sure it will not hurt you, you have lost all the potential for the trade. In this case, the cost of insurance was just too much.
Placing an order far away is not a desirable thing to do. Your order should be far enough away from the break level not to get caught in the noise of the break, but not so far away that your trade is filled at an abysmal level. There is an optimal distance away in pips or dollars to place the order.
Listen to the market
The market speaks. Listen to what it is saying. The price accurately reflects all market knowledge, plus traders' hopes, fears, expectations, frustrations, optimism. If you know the price, you know everything.
At the point of the break (true or false), the market will be shouting (if you care to listen) whether the move is false or true.
Five tests to confirm a break
What does a market sound like when making a true or false break? On a true break, it follows through, and on a false break, it whips back around. So we want a series of tests that tells us early with the best chance of getting the correct answer.
The price must close through the level. If you have defined the level of the break and the price cannot hold it, it did not break. This is true whether it is a daily candle or an hourly candle. The first bar's confirmed break is a minimum. Test 1 is a requirement.
Tests 2-4 are your evidence of a true break. The more they are true, the louder the market is shouting BREAK OUT!
A close at the extreme. The candle (whatever period it is) ends at or near its extreme point. If it is breaking down, closing near its low. If it is breaking up, it's high. Anywhere in the bottom or top third of the candle is shouting. A break down with a close at the very low shows selling was relentless. The market is screaming at you.
A long bar. A long bar is a relative thing. We mean a high-to-low range that is larger than its normal bar range. If you think about it, traders are panicking to buy or sell when ranges are bigger than average. They are breaking the market. Let us say that a normal range would be 20 pips, but the market is willing to sell aggressively at 25 down and still selling at 40 down. This shows an element of desperation, conviction, the power behind the move. A long bar at a breakpoint is another scream from the market.
High volume. This is not easy to see in Bitcoin and the other cryptos. It is also difficult to see in forex and other OTC markets. But you can feel it. You can see by how it is being quoted with frequent or infrequent updates how busy it is. The busier it is, the higher the turnover. The importance of turnover is that it accurately displays the conviction of a move. If a market breaks down and the volume is heavy, it tells you there is power behind the sell-off. It is a screech.
A Gap. An up gap is formed when the current bar's low is higher than the high of the previous bar. The reverse is true for a down gap. These gaps are called breakaway gaps. An up gap is bullish, and a down gap is bearish. The bigger the gap, the stronger the bullish/bearish message. Gaps do not happen often but, if one occurs when a support or resistance level is breaking, the market is yelping Ouch! As the market changes direction or makes a new high or low, sometimes it is explosive. The market may break down, and there are simply no buyers. The sellers are frantic to see and offer down because they must liquidate positions or get short in size. This is the opposite of a gap formed by lack of liquidity.
What noise does a false break make?
When a market breaks a significant level and just whimpers or whispers, it is very likely to be a false break. All the opposites of rules 2-5 indicate no pulse increase or power behind the break down or break up. The price should not close mid-bar on a narrow range day. This candlestick is call a Doji - a message of indecision. If the market is breaking up or down or through a trend line or neckline, it should definitely not be a quiet day. For a technical analyst, these are visual signs of silence.
A break will only be true if it is accompanied by force - noise. A technical break with no force is almost always false or, at the very least, delayed. If you close through a support or resistance level but do not see at least two of Rules 2-5, wait. It may be delayed, and you will hear the noise on the next bar and follow it with confidence. If you do not, you will probably find it was a false break, and the market bounced over the next few bars. Be grateful that the market broke the level, but you were not sucked in with the rest.
To avoid false breaks, don't shout, listen
Using the tests above, you will hear what the market says when your support or resistance level is giving way. So apply these tests, and if test one is fulfilled and at least two of the remaining four are fulfilled, then go ahead.
You are now not relying on some fixed number of
dollars to tell you whether the break is true or false, which may or may not be
correct. You do not jump in too quickly. You're waiting for the rest of the market to tell you that the level is giving way or not. It is the rest of the market which will decide, not you. Don't insist
the market is wrong or it must do something because your level has been broken.
It will tell you, usually clearly, it has broken or held.