Imagine this scenario: you’ve been watching an uptrending currency pair for some time as its price approaches a key resistance level, a point it had not been able to break through several weeks earlier. The price bounces beneath that level for several candlesticks, then pushes through and even closes above it.

Is this the anticipated breakout? Or is this a false breakout, with the price preparing to fall back beneath the resistance level and resume its rangebound ways? Here are several methods to judge a breakout’s credibility.

a) Check the volume against the time of day. Liquidity within the forex trading market is legendary; however, that liquidity is not evenly spread throughout the day nor across all currency pairs. As a rule of thumb, the deepest liquidity within the market occurs during the early portion of the London session, when the serious money take their morning positions, and during the London afternoon, when it overlaps the New York session and both markets are trading simultaneously.

The shallowest liquidity occurs during the end of the Asian session followed by the end of the New York session. Price movements within these times are exaggerated by the lack of liquidity and are often reversed when more money enters the market, leading to false breakouts.

If the breakout under discussion happens during a time of low volume for that currency pair and during a time of low liquidity within the overall market, then the breakout must be considered suspect. On the other hand, if the breakout occurs during high volume trading, it has more credibility.

b) Check the overall trend. A time of consolidation within a range can signal either reversal or continuation. If the currency pair had been trending higher or lower prior to its consolidation, then it would not be surprising to see it continue following a breakout.

Because all traders know that the trend is their friend, a breakout that continues the established trend has more credibility. However, if a breakout reverses the trend, a trader should give it time to prove itself prior to entering the market.

c) Check for chart patterns. If the currency pair has been forming an ascending or descending triangle within its range, that establishes the bullish or bearish pressure and this too gives the breakout credibility, although its lack is not necessarily damning.

Below is a screenshot of the one-hour USD/CAD chart. Since 8 August this currency pair has been testing resistance at 1.0720, only to bounce off and fall back to support at 1.0420. On 3 September, it again reached resistance and this time pushed through.

Volume, indicated by the vertical green lines across the bottom of the screen, is too low for this breakout to have legs, although the 200-period moving average sweeping across the lower half of the chart shows the overall trend is changing from down to up. There is no obvious triangle forming, and therefore the prudent trader would be forgiven for waiting for this breakout to prove itself prior to entering the market.

Shortly after this point, USD/CAD reversed and fell over 100 pips to mid-level support at 1.0595. Three more attempts have been made on 1.0720 but to date none has been successful.