The focus of every trader is to find ways to improve their techniques to win the market. There is nothing more important for a trader than a backtested strategy, regardless of whether they are a scalper, day trader, swing trader, or positional trader. For example, the break and retest forex strategy might not be familiar if you trade indicators instead of price action.
However, you probably are reading this article because you have tried several indicators, EA, and robots, but nothing has worked; or you want to make your strategy more solid and accurate.
Take a look at the break and retest strategy. A good trader is knowledgeable about technical analysis, risk management, and discipline. That is why this is one of the most powerful tools.
What do break and retest mean in Forex?
As a Forex trader, “break and retest” means that a market price has passed a specific structure, only for the price to retrace back to the same structure it had previously passed.
A “break” occurs when the market price crosses a structure, whereas a “retest” involves the return to that exact structure.
What is a break and retest strategy?
Trading breakouts in the financial market is a great way to make money. Generally, an asset will go through a breakout or consolidation in a bull market after it consolidates. Using the strategy properly can yield substantial profits.
A breakout is when an asset, such as a stock, commodity, or ETF, breaks through a consolidation channel. See the chart below for an example. As can be seen, AMC remained a consolidation company for a considerable period.
It created what appeared to be a horizontal channel with resistance at around $15. However, the stock broke out higher in the following days, reaching a $72. This represents a gain of almost 400%.
Because these price movements occur almost every day, you can take advantage of them. For example, a break and retest strategy occurs when an asset breaks out in a bullish or bearish trend and retests its previous resistance or support before continuing in the original direction.
Prices of an asset can move in one direction for a long time, but eventually, this trend has to change, and a new one has to begin. The term “break” is used to describe the situation in which the price has proven stable by support, resistance, trendline, or a channel for some time but has been able to break out of it.
There are two kinds of breaks:
Price breaks support when it is holding the price and moves downwards from a downwards direction.
As the price moves upward from down to up, the resistance holds, and the price breaks it by moving upward.
A retest is when the price comes back and attempts to retest or examine the broken trendline, support or resistance. This also applies to breakouts and breakdowns.
How does the break and retest strategy work?
Break and retest strategies work in a very straightforward manner. Your first step is to identify a financial asset either in channel or consolidation mode. The consolidation phase must end first, followed by retesting.
The occurrence of a breakout means that bulls or bears have prevailed in the market. False breakouts happen from time to time, however. Hence, instead of investing all your money at the start, wait for the price to retest the previous resistance level, which has now become a support level.
Let us explain why this retest happens.
A bullish breakout leads to some buyers rushing to buy the asset and implement buy stops. Some bears enter when the price increases, while some buyers start selling. When this happens, prices tend to fall. Buyers return once it reaches the level of support, pushing the price significantly higher.
A bearish run follows the same strategy.
Several famous chart patterns break and retest, such as:
- Channels: A channel arises when a chart’s resistance and support levels are continuous. Horizontal and diagonal channel types exist.
- Wedge: The wedge pattern occurs when support and resistance levels move in the same direction. A rising wedge usually indicates a bearish breakout, while a falling wedge indicates a bullish breakout.
Thus, the break and retest strategy can help when the pattern is about to break. This chart shows the S&P 500 in a wedge pattern.
- Triangle: A triangle is composed of three types: symmetrical, ascending, and descending. Each of these types generally extends upward and downward. By contrast, a symmetrical triangle typically breaks into both directions. Consequently, a break and retest pattern may occur when these breakouts occur.
- Consolidation: As discussed above, the break and retest can occur after a financial asset has a consolidation period.
Which timeframe is best for the break and retest Forex trading strategy?
All my research shows that sniper entries work best on the M15 timeframe. The M15 is the second-best time frame for break and retest trading. If you enter on a larger timeframe, you’ll most likely experience drawdowns. You could also end up with a bigger stop-loss, adversely affecting your risk-reward ratio.
As a result, risk management practitioners should set shorter entry periods when entering the field.
- The price is likely in a downward trend.
- Assume that a break of this structure signifies a continuation of the downtrend. Then, place your sell stop order at the lowest recent low.
- Stop-loss can go anywhere above the previous lower high.
Best currency pair for a break and retest Forex trading strategy
It’s common to assume that the break-and-retest strategy applies to every trading asset, particularly currency pairs since structures form on every asset. The fact is that not every strategy and not every currency pair will work for you.
For this reason, most expert advisors are only profitable on a limited set of currency pairs. Every pair of currencies has its characteristic (personality) that makes it different from others. There is no doubt that CHFJPY is wicky; that is to say that most candlesticks have long or medium wicks.
A trader must consider how each currency pair moves when using the break and retest strategy as he applies it to different pairs. Notably, not all currency pairs tend to retest broken structures. To put it bluntly, every currency pair breaks a market structure from time to time, but not every currency pair returns to the previously broken structure.
It would be best to keep in mind that this characteristic changes over time. As time passes, those currency pairs (known for testing their broken structures again) will not retract fully to the previously broken structures or vice versa.
In this case, it is essential to note that currency pairs will retest their previously broken structure most of the time. This currency pair may seem best suited for break and retest strategies when that is the case.
Accordingly, the best Forex pairs for a break and retest support and resistance strategy are:
The different ways how price reacts to market structure
From simple observation, it is evident that price reacts to market structures in three different ways under the guise of “touching”. Here are some of them:
It is common for the price to touch the structure, usually in the form of a wick, before reversing.
In this case, the close of the candles is above/below the mentioned structure. Observed on a lower timeframe, this would appear as if the price has broken the pattern and is doing a retest.
When the candle closes above/below the structure, the opposite candle closes above/below the structure in the same topic later.
Due to this, the lower time frames would consider this to be a false breakout. That’s why it’s vital to colour-code your structures and wait for candles from that time frame to break so you can retest them.
In some instances, price doesn’t have the momentum to test a structure up or down. As a result, it is possible to do a slight consolidation or a minor pullback before moving forward.
The best course of action in such cases is to have an alternative strategy to compensate for the failure of the retest.
Trading this strategy requires waiting for the price to reach specific resistance, support, or trendline zones and then breaking and retesting that specific zone. But the wait will be the most challenging part since traders can master the strategy quickly, but they struggle to be patient.
Trade the break, not the retest, if you are a trader. This approach has its ups and downs as well. For example, you might have taken the trade without waiting for the price to retest the support, resistance, or trendline when you saw the price break the support, resistance, or trendline.
You would have missed the trade if you had waited for the trades here. In contrast, you would have missed the best risk-reward ratio if the price had retested the zone after the break.
Risks of using the break and retest strategy
There are several risks involved with this trading strategy, as with all others. Usually, the price breaks out, retests the previous resistance, and continues on its downward path instead of recovering.
You can avoid this risk by entering a long position when the price moves above the initial top level.
After the price experiences a breakout, the following risk comes when it continues with its upward trend without retesting. In other words, if you were waiting for a retest, you would miss an opportunity to trade.
Last but not least, there is the situation where the price breaks out and keeps rising, giving you a reason to conclude that it has established a bullish breakout. You went long when the price made some key moves, only to see it retreat and form the test and retest strategy.
- How do you trade breakout and retest?
When prices retest a breakout level after reversing direction following a break, they test to see if it will hold. A break to the upside, for example, may cause the prices to stall following the initial wave of buying, triggering very short-term profit-taking selling.
- How do you identify a retest?
Retest refers to a price reversal after a break and a return to the breakout level to determine if it will hold. The price may stall after the initial wave of buying has run its course, for example, triggering extremely short-term profit-taking selling.
- Should you always wait for a retest in Forex?
It is always essential to wait for a retest of a broken level when trading a critical horizontal level, wedge pattern or channel. The first step is to wait for the retest and confirm the price action before risking capital.
- When can you enter a retest?
If an asset breaks out bullishly or bearishly, it will retest the previous resistance or support and continue moving in the original direction.
- Should I wait for the retest after breakout?
It may be advisable to retest after a breakout based on relative risk alone. You may need to wait for a retest before considering entry if your required stop loss placement target is too close.
In the market, today, break and retest trading strategies are favoured. They’re popular as they work! However, we have seen that it does present some risks that you should be aware of. For this reason, we recommend using quality risk management strategies to make sure you use them correctly.
Traders can apply the break and retest strategy with price action alone or indicators. Volume is one of the best times to trade any market.
There are some disadvantages to price action, including that it does not determine market volume. The best time to trade is when the volume is high. The worst time to trade is when the volume is low. However, the combination of price action and indicator will produce more accurate trades.
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Heinrich is a forex and CFD enthusiast with a passion for writing good informative quality content. He strives to showcase the best forex brokers in Africa. Join him on his Journey!
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