How to Use the Break and Retest Strategy as a Forex Trader

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Contributor, Benzinga
July 15, 2023

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The break and retest strategy is a common and effective way to trade forex. This approach can help you capture big moves in the forex market, avoid false signals and improve your risk-reward ratio. 

In this article, you will learn how to use the break and retest strategy as a forex trader, the benefits and drawbacks of this approach and how to avoid common pitfalls.

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What is the Break and Retest Strategy?

The break and retest strategy is a simple technique for spotting high-probability trading setups in forex. It follows a basic principle: when a significant support or resistance level is broken, the market tends to retest it before continuing in the breakout direction. Support is where buyers step in to push prices higher, while resistance is where sellers step in to push prices lower.

Here are the two steps of the strategy:

  • Wait for a strong candlestick to break a key support or resistance level, indicating a shift in market sentiment with enough momentum to sustain the breakout.
  • Wait for the price to retest to the same level that was broken, now acting as new support or resistance. Look for a rejection candlestick or reversal pattern at the retest to confirm and enter a trade in the breakout direction.

The strategy helps identify market reversals or continuations based on the breakout context. For example, a major support break after a downtrend could signal an uptrend reversal, while breaking a significant resistance level after an uptrend could indicate the continuation of the upward trend. Applying the strategy to smaller timeframes and minor levels is possible but less reliable and more prone to false signals.

To use the strategy effectively, analyze past support and resistance levels, focusing on those repeatedly tested and showing strong reactions. Draw these levels on your chart using tools like horizontal lines, trendlines, channels or Fibonacci retracements. This helps anticipate breakout and retest areas, aiding in planning entry and exit points.

How Does the Break and Retest Strategy Work?

The break and retest strategy capitalizes on market psychology and supply-demand dynamics. When a key support or resistance level is broken, it signals a shift in sentiment and attracts more traders to join the breakout, causing increased volume and volatility.

However, the price rarely moves in a straight line and often retraces after a breakout. This temporary pullback, a retest, allows traders to validate the breakout and enter or exit trades with lower risk.

Retests test the strength of the breakout. If the broken level holds as new support or resistance, it confirms a genuine breakout. If it fails, the breakout is likely false and the price may reverse.

The strategy uses these scenarios by entering trades at the retest with favorable risk-reward ratios. Waiting for the retest helps avoid premature or delayed entries and reduces exposure to false signals. It also provides clear reference points for stop-loss and take-profit placement using the broken level.

The break and retest strategy can be applied to popular chart formations:

  • Channels: Consist of parallel trendlines forming support and resistance. A breakout above the upper line signals a bullish breakout, while a breakout below the lower line signals a bearish breakout. Trade entries can be made at the retest of the broken trendline.
  • Wedges: Feature converging trendlines within a narrowing price range. Rising wedges suggest a weakening uptrend while falling wedges indicate a weakening downtrend. Enter trades at the retest of the broken trendline.
  • Consolidation: Shows a horizontal price range indicating indecision. Breakouts above or below the range provide trade opportunities. Enter trades at the retest of the range boundary.
  • Triangles: Formed by converging trendlines with symmetrical, ascending or descending shapes. Symmetrical triangles imply uncertainty; ascending triangles suggest bullishness; and descending triangles signal bearishness. Trade entries can be made at the retest of the broken trendline.

How to Break and Retest Forex Trades

Here is how you can apply this strategy to your forex trades.

Identifying Break and Retest Setups

The first step in using the break and retest strategy is identifying potential break and retest setups on the chart. To do this, you need to consider the following factors.

  • Trend analysis: Determine the prevailing trend using trendlines or indicators. Look for breakouts in line with the trend for higher success rates.
  • Chart patterns: Identify patterns like channels, wedges, consolidation or triangles. Strong candlestick patterns (marubozu, engulfing or pin bars) confirm breakouts.
  • Market volatility: Assess volatility with indicators like ATR, Bollinger bands or volume. Seek breakouts during high volatility periods for more momentum.

Setting Up Entry and Exit Points

Establish entry and exit points that align with the break and retest strategy. 

  • Entry point: Confirm the retest using technical indicators like moving averages, Fibonacci levels or candlestick patterns. Enter the trade when you observe rejection or reversal signals at the retest level.
  • Stop loss: Set your stop loss slightly below or above the retest level, using it as a guide. This protects your trade from false breakouts or sudden price spikes.
  • Take-profit: Determine your take-profit level based on the risk-reward ratio and market conditions. Use indicators like moving averages, Fibonacci extensions or key support/resistance levels to estimate likely targets.

Backtesting and Analyzing Trade Results

The third step is backtesting and analyzing trade results to gain insights into the effectiveness and performance of your break and retest strategy.

  • Backtesting: Test your strategy on historical data using platforms like MT4/5, TradingView or Forex Tester. Replay past price movements and execute trades based on your rules. Select a suitable timeframe, currency pair and period for backtesting.
  • Analyzing results: Use metrics and statistics to assess your strategy's performance. Common metrics include win rate, risk-reward ratio, profit factor, maximum drawdown and Sharpe ratio. Look for a strategy with a high win rate, high risk-reward ratio, high-profit factor, low drawdown and high Sharpe ratio.

Common Mistakes to Avoid

The final step is to avoid common mistakes.

  • Chasing trades: Wait for proper confirmation of the retest before entering a trade. Avoid entering too early or too late, as it can result in unfavorable prices or false breakouts.
  • Overtrading: Consider market conditions, risk-reward ratios and currency pair correlations. Avoid entering too many trades simultaneously, as it can increase exposure, transaction costs and reduce diversification.
  • Ignoring key technical indicators: Pay attention to trend analysis, chart patterns and market volatility. Disregarding these factors may lead to trading against the trend, low-probability trades or trades with weak momentum.

To prevent these mistakes, adhere to your trading plan, practice proper risk management and exercise discipline and patience. Regularly review your trades and learn from your mistakes to improve your skills and confidence as a break and retest trader.

Discover Break and Retest: A Winning Forex Trading Strategy

The break and retest strategy involves entering trades at the retest of a level broken by the price. This approach can help you spot market reversals or continuation patterns, depending on the context of the breakout. You need to analyze the trend, the chart patterns and the market volatility to identify break and retest setups. You also need to use technical indicators to set up entry and exit points and to backtest and analyze trade results. It can be effective if you avoid mistakes such as chasing trades, overtrading or ignoring key technical indicators. 

Frequently Asked Questions 

Q

What is a retest in trading?

A

A retest in forex trading is the price action that occurs after a breakout, where the price returns to the level that was broken and tests it as a new support or resistance level.

Q

Should traders wait for a retest after the breakout?

A

Waiting for a retest after the breakout can be beneficial, as it can confirm the validity of the breakout and provide a better entry point with a lower risk.

Q

Is break and retest the same as a breakout?

A

Break and retest is not the same as breakout. A breakout is the initial price action that breaks a key support or resistance level, while break and retest is the subsequent price movement that retests the same level as a new support or resistance level.

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