Breakout vs Reversal

There are thousands of trading strategies, but all of them fall under one of two categories. They are either looking for breakout or expecting a reversal.

What is a Breakout strategy?

A breakout strategy is looking for signs that the price is about to break a support or resistance level. The expected outcome is that once the price broke the level it will continue moving in that direction. Most breakouts occur after periods of consolidation. Depending on the current market sentiment, some breakouts are very strong, sometimes resulting in couple of hundreds of pips. In contrast there are situations where the prices move gradually after the breakout. In either case the breakout is a sign of the start of a directional move. This can either result in a new trend or widen the price range of the current consolidation.

What is a Reversal strategy?

A reversal strategy is expecting a the price move to change its current direction and retrace back. There expectation can be based on the presumption that all short term price moves are “noise” and the price will return back to its “mean”. Another assumption is that the price will retrace if it fails to break a support or a resistance level. In both cases the trader is placing orders counter to the current market move, expecting the price to go back to “normal”.

Which strategy is better Breakout vs Reversal?

There is no clear winner in an argument Breakout vs Reversal. The truth is that both strategies can be profitable, depending on the current state of the markets. A good trader should be comfortable with several trading strategies and use them accordingly.

Breakouts tend to occur less frequently, but result in bigger price swings. Trading strategies which are based on breakouts usually let the positions run longer with wider profit targets. In contrast reversal strategies occur more frequently, but have limited profit potential. As a result trading strategies based on reversal tend to have larger number of trades, which have short duration and limited profit.