A breakaway pattern is a candlestick formation which is recognised by investors as a signal that an asset or security is about to experience a reversal. The pattern is made up of five candles and is easily recognisable due to the strict criteria for being confirmed. To understand how to identify a breakaway formation, it’s important that you first know how to read a candlestick chart.
What does a Breakaway Pattern look like?
A breakaway pattern can be either bullish or bearish, depending on what kind of trend it follows and how it is formed. A bullish breakaway follows a downward trend and begins with a long red candle. Next, a gap down to the second candle which starts a series of three spinning tops, each lower then the last. Finally, a fifth candle opens above the close of the fourth candle and closes green, above the open of the second candle, showing that the bulls have managed to push the price back up to the level of the gap down.
A bearish breakaway is the exact opposite. It follows an upward trend and begins with a long green candle. Next, a gap above and three green spinning tops, each of which is slightly higher than the last. Finally, a small gap down and a long red candle which closes below the open of the second candle confirms the pattern and traders can expect the start of a new downward trend.
How to trade a Breakaway Pattern
The most common way traders would approach a bullish breakaway is to wait for all five candles to play out so that the signal is confirmed and then place a “call” or “buy” trade at the top of the fifth candle. Ideally, a stop-loss should be placed at the low of the fourth candle just in case the outcome isn’t as predicted. What some newbie traders may try to do is to catch the gains of the fifth candle by jumping into the trade prematurely. While this can play out as expected and leave the trader feeling like he’s just cheated the system, it is also very risky as he’s not waited for confirmation of the signal.
Similarly, a bearish breakaway can be traded by placing a “put” or “sell” trade at the bottom of the fifth candle with a stop-loss at the peak of the pattern in case something goes wrong. Bearish patterns tend to be more reliable than bullish ones and the appearance of a bearish breakaway would certainly be a signal to get out of any pre-existing longs.
As always, candlestick patterns signal the possibility of a certain movement, but they do not predict it. There is no such thing as a crystal ball to tell traders exactly what is going to happen in the market. Using technical indicators such as the MACD or RSI to look out for signs that the market is overbought or oversold can add weight to the signals being given by these candlestick patterns. Remember, the aim of the game in trading is to not lose money!