One of the most frustrating situations that can happen in forex trading is getting faked out. Here is an example.
Say you are placing a trade based on price action. You see an inside 4 bar (I4B) form, which is a consolidation pattern. You know the price is likely to break out in one direction or the other, so you set entries on either side of it. Your sell order triggers and the price moves up. But then, suddenly, it drops abruptly back down and you get stopped out. You were faked out.
Then, to add to your frustration, sometimes the price may rebound, climbing back up again. At that point, not only did you get stopped out, but you ended up missing out on the very move you expected!
Fakeouts are very common when trading forex, and if you do not take steps to avoid them, they will catch you time and again.
So, what can you do about them? In this post, we will offer a few simple recommendations.
1. Trade in favorable conditions.
One of the most common mistakes newbie forex traders make is jumping into trades without paying attention to the contexts surrounding their setups.
If the market has been relatively smooth lately without a lot of whipsaws, you are less likely to get faked out.
But if the market is already showing lots of random spikes up and down, you have every reason to expect that additional whipsaws and fakeouts are coming up.
So, even if you have a signal telling you to trade, you might want to hold off—or at the very least, be ready for fakeouts.
2. Look for multiple signals to align.
If you regularly get faked out, it could be that your trading method just is not robust enough, and you need to look for higher-quality setups.
One way you can do that is to wait for multiple indicators to tell you it is time to make a trade.
As a random example, let’s say you are looking at the Williams Percent Range indicator, and it is telling you that the market is overbought, so you are thinking of placing a sell order.
You could just go ahead and trade, but by itself, this indicator does not necessarily give you enough information to make reliable predictions.
So, you could look for confluence with another indicator. Perhaps, for example, you see a moving average crossover simultaneously. Or maybe you see a pinbar forming, indicating a price reversal.
You do not want too many components in a trading method, or you will end up with conflicting signals, clutter, and confusion.
But you do typically want 2-3 components so that you can look for multiple things telling you it is really time to trade.
Continuing with our example, let’s say the Williams Percent Range indicator suggests overbought conditions, and you have a pinbar that looks like it is forming at a swing high.
These are both signaling a drop in price. So, you are less likely to get faked out with this setup than you would one that only had a single indicator telling you to trade.
3. Know where support and resistance are.
In general, the more aware you are of support and resistance levels, the less likely you are to get faked out.
It is common for prices to test support and resistance levels, but then end up bouncing back off of them in the opposite direction or to continue consolidation.
With some practice, you should be able to identify support and resistance levels almost effortlessly at a glance.
You might want to mark them on your charts anyway, just to have a visual aid. And don’t forget that if you are looking at a lower timeframe, it can be easy to miss broader support and resistance levels you could identify easily on a higher timeframe chart.
4. Wait for the retracement.
So far, these recommendations have focused on strengthening your understanding of the market context and looking for superior setups to avoid getting faked out.
But even in a smooth market with a solid system, fakeouts can still happen. Thankfully, there is a simple technique you can use to greatly reduce your exposure to them, and that is to wait for retracements before entering trades.
What is a retracement? It is what we call it when the price makes a little zigzag before moving strongly in the direction you expect.
So, say you want to sell EUR/USD at a swing high, expecting a price reversal and an ensuing downtrend.
Price makes an initial jump downward, testing support. But then, it leaps back up. Shortly thereafter, it resumes its downward movement, pushing successfully through support and creating the trend you were expecting. What we have just described is an example of a retracement.
A retracement is not a fakeout. It is just a somewhat choppy start to a trend. In our example, it would be a fakeout and not a retracement if, after the initial reversal against your position, it then did not successfully break support and resume movement in the downward direction.
Here’s the challenge: How do you tell a retracement from a fakeout while it is happening?
Obviously, you can tell the difference afterward. But when you are trading, you do not have the benefit of being able to see into the future.
Because that is the case, often the wisest approach is just to wait and see.
Instead of selling EUR/USD right away in this example, you would note the upcoming support level and expect that the price will hesitate there and possibly retrace.
You would wait for the price to make its initial drop, then see what happens when it reaches the support line.
If it continues downward, great! There was neither a retracement nor a fakeout, and you can enter and get in on the movement.
If it bounces back upward, then either a retracement is forming or the initial drop was a fakeout. You will have to keep waiting to find out which.
Once the price returns upward, it will either:
- Drop back down, potentially producing the trend you were looking for (in that case, it was a retracement, and you can then get in on the trend by making a sell order).
- Resume the previous uptrend (it was a fakeout).
- Consolidate or range sideways in some fashion, possibly involving more whipsaws (in which case it was a fakeout).
Where should you enter a retracement? That depends on your trading system, but what you might want to do in this example is wait for the price to break the support it initially retraced off of, and then enter.
The downside of waiting for a retracement to complete is that you can miss the initial part of a trend. But if it is a strong trend, you should still have the chance to collect a lot of pips before you close your position.