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What is a Fakeout in Trading?

Fakeouts, also known as traps, are a common occurrence in the world of trading. They occur when a market moves in a direction that initially appears to be a breakout, but ultimately ends up reverting back to its previous price range. This can be a frustrating and costly experience for traders, as they may have entered a position based on the false assumption of a trend continuation. In this article, we will explore the various types of fakeouts and how traders can identify and manage them.



Types of Fakeouts:

There are several types of fakeouts that traders should be aware of:

  1. Bull Trap: This occurs when the price of an asset appears to be breaking out to the upside, but ultimately falls back down and closes below the entry price. This can be particularly frustrating for traders who have gone long on the assumption of a bullish trend continuation.

  2. Bear Trap: This is the opposite of a bull trap and occurs when the price of an asset appears to be breaking out to the downside, but ultimately rallies and closes above the entry price. This can be especially misleading for traders who have gone short on the assumption of a bearish trend continuation.

  3. Breakaway Gap Fakeout: This type of fakeout occurs when there is a gap in the price chart that appears to be a breakout, but ultimately fails to hold and the price returns to its previous range.

  4. Island Reversal Fakeout: This type of fakeout occurs when there is a gap in the price chart that is followed by a series of candlesticks that appear to be a reversal, but ultimately fails and the price returns to its previous trend.

Identifying Fakeouts:

So how can traders identify fakeouts and avoid being trapped? Here are a few strategies:

  1. Look for volume: One way to differentiate a genuine breakout from a fakeout is to look at the volume of the move. If the volume is significantly higher during the breakout, it is more likely to be genuine. On the other hand, if the volume is low during the breakout, it may be a fakeout.

  2. Use technical indicators: Another way to identify fakeouts is to use technical indicators such as the Moving Average Convergence Divergence (MACD) or the Relative Strength Index (RSI). These indicators can help traders identify potential trend reversals and avoid being caught in a fakeout.

  3. Wait for confirmation: It can also be helpful to wait for confirmation of a breakout before entering a position. This may involve waiting for a follow-through day or a break of a key resistance level.

Managing Fakeouts:

If you do find yourself caught in a fakeout, it is important to have a plan in place to manage the trade. One strategy is to use a tight stop loss to minimize any potential losses. Another option is to hold onto the position and wait for the price to revert back to its previous trend. It is also a good idea to review your trade plan and identify any potential mistakes that may have led to the fakeout.


Conclusion:

Fakeouts can be a frustrating and costly experience for traders, but with the right strategies and mindset, it is possible to identify and manage them. By looking for volume, using technical indicators, and waiting for confirmation, traders can increase their chances of success and avoid being trapped in a fakeout.


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