A fakeout is a false breakout that occurs when the price moves outside of a chart pattern but then moves right back inside it. A fakeout is also known as a “false breakout” or a “failed break“.
When the price finally “breaks” out of a chart pattern, which is a support or resistance level, one would expect the price to keep moving in the same direction as the break.
If a support level is broken, that means that the overall price movement is downwards and traders are more likely to sell than buy.
Conversely, if a resistance level is broken, then the crowd believes that the price is more likely to rise even higher and will tend to buy rather than sell.
What does happen is that most breakouts FAIL.
Potential fakeouts are usually found at support and resistance levels created through trend lines, chart patterns, or previous daily highs or lows.
Fakeouts can lead to significant losses and that is why stop losses should always be used to control risk.
Common Indicators
Technical analysts often examine multiple patterns on a single technical chart to confirm trading signals. Envelope channels, which track price patterns over a long-term timeframe, are considered reliable by investors. These channels create upper and lower trendlines, forming a channel that outlines the expected trading range for a security’s price.
There are various envelope channels used for range indicators, with Bollinger Bands being the most popular. Although prices typically stay within their banded range, they can break out above or below the resistance and support lines, resulting in potential false signals.
Trend channels are another common pattern but carry higher risk compared to envelope channels. They focus solely on a security’s short-term trend and don’t include reversals. Trend channels follow a cycle involving breakout, runaway, and exhaustion gap phases. Identifying an exhaustion gap and potential reversal poses a risk of false signals since it’s challenging to determine when a reversal truly occurs.