Failed Breakdowns, Failed Break Outs

In the previous article we looked at break outs and confirmation, and we learned the difference between false break outs (break out initiation) and backtests from where a break out (or break down) potentially fails. The next progression in our learning is to understand how to spot reversals initiating and confirming, using the exact same principles that we discussed in the previous instruction.

The tools we have from the first article are the EMA9 Push (9BT) and the backtest (BT). In this article we will discuss reversal triggers (RT) and explain how they initiate reversals. Each of these abbreviations is listed in alphabetical order in the Terminology section (opens in a new tab for quick reference).

This is part two of a set of two instructions:

• Break Outs
• Failed Break Outs / Failed Breakdowns

Part Two: Failed Continuation (Reversals)

Before we get started, please understand that it is essential that you have read part one. At the end of the first instruction I explained that the break out fails below the last higher low before the higher high. There is logic in play here. A break out can’t fail unless price is actually attempting to break out.

As before, a setup initiates when price looks above a previous high, exhausts and pulls back into the EMA9. The best trades come from consolidation ranges, and these break outs or failed breakdowns are the ones that require the most discipline and patience. In the example we will be using for this instruction, price is coming into exhaustion from a significant downtrend and has spent time sideways to consolidate and build structure. We call this “price discovery”.

Price discovery has allowed us to identify support and resistance – these are always the zones, the levels that have seen the move buying or selling activity. We can draw a zone to highlight this ‘base’, so that we may easily spot when price is attempting a break out or break down.

Fig. 1 below details price discovery, support, resistance, and a “look above” to initiate a break out attempt.

From the previous instruction we know everything that has to happen before we can actually say that this asset is attempting to break out. Study the previous instruction to understand the next few steps. For this article we will simple skip forward to the ‘9BT’ and the ‘BT’ entries.

Fig. 2 below illustrates a break out with all parameters met. We are long and looking for displacement.

The best days come from break out setups that are easy to read, easy to trade, and then immediately displace higher. We have these in the Discord regularly, but of course these don’t set up every single day. Regardless, not all of them work. This depends largely on what the higher timeframe is doing. If you imagine for example that this is an hourly dip into a trending daily EMA9, this break out is high probability, but this is an hourly downtrend coming into exhaustion while price is below the daily EMA9, then there is a lower success rate. You will typically get 1R, 2R, perhaps more, but when the higher timeframe provide ‘headwinds’, there is a chance that a backtest break out exhausts and sets up a reversal.

Reversals form in the exact same way, except into the opposite direction: exhaustion and a sweep, as illustrated in Fig. 3 below.

Some break outs reverse aggressively, and that is why we have our stop below the initial higher low, but if sellers now step in and take out that HL2, the trade fails and we have to cut our position in anticipation of more consolidation or deep pullbacks.

Because we don’t know if price will give us deep pullbacks or more consolidation, the understanding that we will see at least a small stop run makes this failed break out a potential short scalp, typically good for 1R (Fig. 4). The logic behind this is simply that we aren’t the only ones that took the long, and we are likely not the only ones stopping out.

Regardless of whether we want to scalp a short, the point here is that the long failed, and we have to wait for the next setup.

Fig.4 below illustrates a completed failed break out.

Failed Breakdowns at the End of Downtrends

At the end of downtrends, price first has to come into exhaustion and initiate a break down (continuation). As discussed before, a break down, the same as a break out, has to sweep the exhaustion pivot – which becomes the setup low – and backtest the EMA9 for a lower high so that sellers may attempt continuation lower (Fig. A below).

Because we understand what has to happen to confirm this breakdown, we also understand where the first sellers might have their buy stops. The best reversals come from failed breakdowns, because they involve trapping (Fig. B below).

Failed swings are reversals that don’t trap sellers first. These are riskier to buy because essentially, sellers are just looking for a lower high. Failed swings become bear traps if the 9BT entry doesn’t extend. Then sellers return to the setup low and potentially give that desired reversal there instead (Fig. C below).

It is imperative to understand that expanded EMA clouds need time to turn. An initial failed breakdown targets the EMA9, and if there are enough buyers to take that out, the EMA21 becomes the next area of focus. Therefore, the initial reversal has to be treated as a technical scalp, but we can take it with conviction, and price may V-Shape out of this reversal directly. Protecting your capital by taking aggressive partials, then leaving runners allows you to participate in V-Shape recovery, but the best trades initiate when price spends time at the low, contracting.

Fig. 5 illustrates a reversal scalp that rejects at the trending EMA9 before an A+ reversal setup forms.

Out of the above described reversal setup, buyers may break out directly (typical when the higher timeframe is in a strong uptrend), or price may consolidate sideways before ultimately attempting a break out.

A good strategy is to buy the initial failed breakdown, take partials into resistance to negate risk, then patiently wait for an A+ break out setup to form, or fail and end the trade.

Fig. 6 illustrates a failed breakdown, followed by a reversal (EMA9 acceptance) and a break out.

Price can continue sideways endlessly, and our job is to recognise A+ opportunities to define risk and make money.

Fig. 7 below shows the above example on a real price chart.

The challenge with understanding price action is that at some point you see setups everywhere. Therefore, context is key. Context comes from higher timeframe trends and major price levels. The model allows you to define risk and make informed decisions.

An Example

Price comes into exhaustion after a strong downtrend and arrives at a key level (Fig. 8). This can be anything. A gap fill, an old high, it doesn’t matter. What matters is the trade plan, and we have planned that this level is a strong zone where we should look for a reversal attempt.

The context tells us what to look for. If we are planning to look for a long, then we spend time waiting to see if continuation lower fails. We know what sellers have to do, so we only have to wait for that to fail.

Lucky day is when price immediately makes a failed breakdown to allow us an immediate long (Fig. 9). As discussed, after price reclaimed the EMA9, the EMA21 posed resistance. After that initial rejection, the EMA9 HAS to lead, otherwise price returns to the low.

So now we have looked at continuation, failed continuation, and a simple example of context. The latter simply tells us what we should be looking for as price comes into pre planned levels and zones.

Diagonal Entry Model

Barky’s Diagonal Entry Model is based solely on these two principles (continuation and failed continuation) and to complete these introductory tutorials, here is the setup from figure 9 with the Diagonal Entry Model drawn onto it (Fig. 10).

The Diagonals serve to set alerts and tell us the setup. We can draw a trend line from a breakdown candle over a lower high, then be alerted when price breaks that downtrend.

Here is an $NVDA bear market chart. This is a weekly sideways range and price consistently fails the break outs, only to give long at support each and every time. Can you spot the reversals and break outs in line with the tiny cheat sheets that are displayed in the lower left corner? (click on image to enlarge).

This concludes the entry model. For the next article in this progression, we will look at day trading, then swing trading: using a higher timeframe for context and a lower timeframe to define risk. In the Discord, we use these concepts, this model, to day trade NQ with live video guidance. We also swing $SPY, $QQQ and of course ES and NQ intra day.