The financial markets are full of traps designed to trick traders into making poor decisions. One of the most deceptive market structures is the fakeout pattern, which occurs when price action appears to break a significant level but then quickly reverses. Many traders fall victim to fakeouts, but with the right strategy, you can trade them profitably instead of being caught in the trap.
This guide will help you understand what a fakeout is, why it happens, and how to develop a profitable trading strategy around it.
What Is a Fakeout Pattern?
A fakeout occurs when the price appears to break through a support or resistance level but then quickly reverses, trapping traders who expected a breakout. It often happens in:
- Support and resistance zones
- Trendlines and channels
- Chart patterns like triangles and head-and-shoulders
- Key psychological levels (round numbers, previous highs/lows)
Fakeouts can be frustrating, but they are also great opportunities to enter trades in the direction of the reversal.
Why Do Fakeouts Happen?
Fakeouts occur due to market manipulation and trader psychology. Some common reasons include:
- Institutional Stop Hunting – Large institutions push the price beyond key levels to trigger stop losses before moving in the opposite direction.
- Retail Trader Traps – Many retail traders place orders at obvious breakout levels, making them easy targets for smart money.
- Liquidity Grab – Markets seek liquidity, and stop orders provide the fuel needed for big players to enter at better prices.
- False Momentum – Sometimes, an initial breakout lacks strong volume, making it unsustainable, leading to a sharp reversal.
How to Identify a Fakeout?
Recognizing a fakeout can help you avoid unnecessary losses and capitalize on trading opportunities. Here’s how you can spot them:
1. Volume Analysis
- Low volume on the breakout often indicates a lack of real buying/selling pressure.
- High volume reversal suggests institutional involvement and the likelihood of a fakeout.
2. Wick Rejections and Candlestick Patterns
- Long wicks (shadows) at key levels indicate rejection of higher or lower prices.
- Engulfing candles show strong reversals after the breakout attempt.
- Pin bars and shooting stars often signal fakeouts.
3. Price Action Confirmation
- If a breakout occurs but fails to hold above/below the key level and quickly reverses, it’s likely a fakeout.
- A retest of the level after the false breakout can confirm a fakeout trade setup.
How to Trade the Fakeout Pattern?
Here’s a simple yet effective strategy to trade fakeouts:
1. Identify Key Levels
- Mark support, resistance, trendlines, and psychological levels on your chart.
- Watch for price approaching these areas with increased activity.
2. Wait for the Fakeout Confirmation
- Observe a breakout followed by a quick reversal back inside the range.
- Look for candlestick rejection patterns (like pin bars, engulfing candles, or dojis).
- Check if the breakout had low volume, followed by strong reversal volume.
3. Enter on the Retest
- Once the price returns inside the range, wait for a retest of the broken level.
- Enter a short trade if the fakeout was a false breakout to the upside.
- Enter a long trade if the fakeout was a false breakout to the downside.
4. Set Stop Loss and Take Profit
- Stop loss: Place it just above (for short trades) or below (for long trades) the fake breakout level.
- Take profit: Aim for at least a 2:1 risk-reward ratio.
- Trailing stop: Consider locking in profits as price moves in your favor.
Example of a Fakeout Trade
Imagine a stock has a resistance level at $100. The price breaks above $100, attracting breakout traders. However, instead of continuing up, it quickly drops back below $100.
- A trader recognizing this fakeout waits for a retest of the $100 level.
- If the price rejects the level again, the trader enters a short position.
- A stop loss is placed slightly above $100, and a profit target is set at the next support level.
This is a classic fakeout trade setup that can be repeated in multiple markets.
Final Thoughts
Fakeouts are a common market phenomenon that frustrates many traders. However, by understanding why they occur and learning to identify and trade them effectively, you can turn them into profitable opportunities.
Key Takeaways:
✔ Fakeouts happen when price action deceives traders at key levels. ✔ Institutional traders use fakeouts to manipulate retail traders. ✔ Volume, candlestick patterns, and retests help confirm fakeouts. ✔ A well-structured fakeout strategy can help you profit instead of getting trapped.
By mastering the fakeout pattern, you can enhance your trading edge and avoid common pitfalls that trap inexperienced traders.
Do you trade fakeouts? Share your experience in the comments below!