Forex Trading Strategy

What is the London Breakout Trading Strategy? A Simple Explainer

London Breakout Trading Strategy

The London Breakout is a popular forex day trading strategy used by traders to capitalize on the high volatility during the London market open. This strategy aims to catch breakouts from key support and resistance levels as increased volume from London traders causes prices to break out of recent ranges.

In this comprehensive guide, we’ll explain what the London Breakout strategy is, how it works, tips for trading it, and the pros and cons of using this strategy. Whether you’re a beginner looking to learn a simple day trading strategy or an experienced trader wanting to incorporate breakouts, this article will walk you through everything you need to know about trading the London Breakout.

How the London Breakout Strategy Works

The London Breakout aims to capture volatile price moves during the first few hours of the London trading session, which is one of the busiest forex trading sessions. Here are the key details of how this strategy works:

  • Trading Session: The London session starts at 3 AM EST as London opens for business. This overlap with the New York session leads to high volume and volatility during the first few hours of London trading. This volatility is where breakout opportunities occur.
  • Trading Time: Trades are taken shortly after the London open around 3 AM EST up until around 5 AM EST when volatility tends to wane. Trades target the initial volatile price action for quick profits.
  • Trading Direction: Trades can be taken in either direction since the London open leads to both upside breakouts and downside breakouts. Traders analyze support and resistance to determine the direction of the breakout.
  • Breakout Confirmation: Traders wait for a confirmed break and retest of support or resistance to identify a valid breakout. A volatile thrust of price followed by consolidation suggests a directional move.
  • Profit Targets: Initial targets are placed near recent swing highs or lows. Additional targets can be set at key levels and trailing stops used to lock in profits as the price move extends.
  • Stop Loss Rules: Stops are placed just outside key support and resistance levels to allow for some volatility. Stops must be used to define and limit risk on all trades.
  • Risk Management: As with all trading strategies, proper risk management is essential. Risk is kept small, around 1-2% of capital, so that adequate capital is preserved to offset inevitable losing trades.

Now that we’ve looked at how the London Breakout works in theory, let’s walk through an example setup and trade…

Step-by-Step London Breakout Trade Example

Here is how a typical London Breakout trade might work in practice:

Step 1) Check for key support and resistance levels on the 1 hour chart leading up to the London open. In this example, the EURUSD had been respecting 1.1975 as support and 1.2050 as resistance.

Step 2) As the London session opens, watch for price to break out of this range with volatility and high volume. A strong move below 1.1975 would signal selling momentum, while a move above 1.2050 suggests upside breakout.

Step 3) Wait for a confirmed break and retest of the support or resistance level to validate the breakout. Avoid trading right at the open and give price time to retest.

Step 4) Enter a short position with a stop above the resistance level if support breaks. For an upside breakout of resistance, buy with a stop below the support level.

Step 5) Set a profit target near the next significant swing level where prices are likely to meet resistance or support. Trail stops to lock in some profits if the move extends.

Step 6) Close out the trade at your target or stop loss and avoid holding into mid-day when volatility declines. Repeat these steps for other opportunities during the active London session.

Tips for Trading the London Breakout Strategy

Here are some tips for getting the most out of the London Breakout strategy:

  • Trade in Direction of Momentum – Look at previous days to gauge overall momentum. Trade breaks in the direction of the prevailing trend.
  • Focus on Clear Breakout Pairs – Some currency pairs are more likely to trend while others consolidate. Focus on volatile pairs like GBPUSD and EURUSD.
  • Use Low Exposures – Trade 1-2% of capital per setup to withstand inevitable stop outs. Re-evaluate if losing 3+ trades in a row.
  • Define Risk Points – Identify clear support/resistance levels and place stops just outside of these points. Know your risk before entry.
  • Set Realistic Profit Targets – Target previous swing points or key moving average/Fibonacci levels for profits rather than excessive risk.
  • Adjust for News Events – Be aware of any scheduled news events that could lead to increased volatility and wider stops.
  • Stop Trading After 5 AM EST – Liquidity and volatility tend to decline after the first few hours of London trading. Close any open trades.
  • Use Volatility Indicators – Volume or volatility indicators can confirm when volatility is picking up during the active hours.
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By following these tips, you can better apply the London Breakout strategy and improve your chances of trading success. Next, let’s take a look at the key pros and cons.

The Pros and Cons of Trading the London Breakout

Here are the main advantages and disadvantages of employing the London Breakout strategy:

Pros:

  • Simple strategy ideal for beginners
  • Takes advantage of surges in volatility
  • Clear entry/exit rules
  • Trades in alignment with momentum
  • Potential for large profit vs. risk

Cons:

  • Requires waking early to trade 3-5 AM EST
  • Only provides opportunities early in London session
  • Requires consistent volatility at open
  • Not aligned for range-bound markets
  • Stopouts can occur with volatile price action

As with any trading system, the London Breakout has its own set of benefits and drawbacks. Adjust expectations and employ proper risk management when using this strategy.

Common Questions About the London Breakout

Here are answers to some frequently asked questions about trading the London Breakout strategy:

What is the best currency pair to trade for London Breakout?

The GBPUSD and EURUSD tend to be the best pairs to trade as they offer good volatility during the London session. Other European pairs like GBPJPY can also work well.

What time frame should be used for trading the breakout?

The one hour chart is ideal as it shows recent key support and resistance levels leading up to the London open. Also use 15 minute charts for timing entry on the breakout.

How long should my stop loss and profit target be?

Stops are often 20-30 pips beyond defined support/resistance levels. Profit targets can be set 50-100 pips or further using a trailing stop to maximize large moves.

Can this strategy be traded with options?

Yes, options can be used to trade the breakout directionally if properly timed before market open. Use out-of-the-money strike prices aligned with the expected breakout direction. Manage winners early.

Is the London Breakout profitable in ranging markets?

This strategy performs better when there are clear trends and momentum. Choppy or ranging markets make it difficult to identify clear breakout levels to trade from.

How can I improve my accuracy with the London Breakout strategy?

Watch for failed breakouts and fakeouts that reverse shortly after open. Focus on quality setups, manage risk, and fine tune strategy rules for your trading style.

By reviewing these frequently asked questions, you can gain further insight into applying and improving your own London Breakout trading.

Final Thoughts

The London Breakout aims to capture volatile moves at the market open. By trading breakouts in alignment with momentum, this strategy provides a high risk-reward way to profit from surges in volatility. Pay attention to risk management, as stopouts are inevitable when trading breakouts.

Use the tips covered to properly identify textbook London Breakout setups. With the right expectations, this simple strategy can become a profitable component of an overall day trading plan. The key is staying disciplined, focusing only on high-probability trades, and maintaining a 1:1 or better risk-reward ratio.

Hopefully this guide provides everything you need to understand and implement the London Breakout strategy in your own forex trading. Use the knowledge gained to capitalize on breakout opportunities during the active London session.

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