London Breakout Strategy – Rules And Performance (Backtest)
Last Updated on February 25, 2023
If you are a forex day trader and looking for an effective way to beat the smart money, the London breakout strategy may be your guy. Wondering what the London breakout strategy is?
Also known as the London daybreak strategy, the London breakout strategy is a day trading strategy that seeks to trade the upward or downward breakout of the day’s trading range that’s formed before the opening of the London session. This breakout usually happens within the first three hours into the London session. if the breakout is to the upside, traders take long positions, and if it is to the downside, traders take short positions.
In this post, we take a look at the London breakout strategy, and at the end of the article we present a backtested London breakout strategy.
What is the London breakout strategy?
As you may already know, a breakout trading strategy attempt to identify the moment the price breaks above or below a trading range, signaling a transition from a range to a potential trend. Each trading day in the forex market is categorized into three time zones — the Asian session, the London session, and the New York session.
Overlapping with the late Asian session and the New York session, the London session accounts for a major chunk of forex transactions each day, and thus, presents the highest liquidity and volatility, which traders try to take advantage of. One way traders do it is to trade the breakout of the day’s trading range prior to the opening of the London trading session.
The London breakout strategy, therefore, is a day trading strategy that seeks to trade the upward or downward breakout of the day’s trading range that’s formed before the opening of the London session. This breakout usually happens within the first three hours into the London session. if the breakout is to the upside, traders take long positions, and if it is to the downside, traders take short positions.
The rationale behind the London breakout strategy is that the London session is the most liquid session of the trading day and often has the best price movements. The London session often sets the tone of the trend of the trading day. To trade the strategy, you have to mark the range of the Asian trading session and wait for the price to break out of that range during the London session.
The London range defined – example
In this context, the London range is the trading range established by the market before the London market opens. It is the trading range of the Asian trading session.
During the Asian session, the price movement establishes a support level (the lowest level it ever got to) and a resistance level (the highest level it ever got to). Together, these levels form the boundaries of the range, which can present trading opportunities when the price breaks either of them during the London session.
There are two ways to define this trading range:
The high-low range
The common way of establishing the London range is by marking the highest and the lowest price of the Asian trading session. This high-low range considers the whole price action of the trading session. See the chart below: the Asian session has a brown background, the Frankfurt hour has a grey background, while the London and New York sessions have dark-blue and black background colors respectively.
The open-close range
The method ignores the candle wicks and focuses on the highest and lowest opening/closing prices of the Asian trading session to define the range (the body of the candlestick). See the chart below:
Since the bulk of the trading volume happens inside the body of the candle, ignoring the wicks makes it easier to see the price action that matters. This may make it easier to spot breakouts earlier.
Interestingly, the breakout can happen the hour before London open, which is the time Frankfurt and other European markets open. In the chart above, which is the day’s trading chart as of writing, you could see that the price broke above the Asian range during Frankfurt open and continued in that direction for the rest of the trading day.
Why should the London breakout strategy work?
The London open breakout strategy works due to many different reasons. The most common reasons are as follows:
- The Asian session is usually the least volatile session and as such, the trading range is often narrow. Given that, a breakout on either side of the range is expected when the more volatile London session opens.
- Retail traders tend to put their buy and sell stop orders above and below the Asia trading range in anticipation of a breakout. These buy-and-sell stop orders become an easy target for smart money who need liquidity to fill their large orders, so they usually push the price over to capture the stop orders.
- Overlapping the New York market, the London market is where the bulk of the day’s price movements happen and it sets the tone for the day’s trend.
What is the London breakout indicator?
The London breakout indicator is a custom forex trading indicator designed to help traders easily spot and trade the London session breakout opportunities. It is a complete London breakout forex system that is quite popular among currency traders who like to trade the London breakout opportunities. It is a custom indicator, and there are different types.
Depending on the trader that created it, it might focus on the breakouts only or a combination of breakouts and fake breakouts. Most of them come with entry levels for both buy and sell trades accompanied with the take profit levels. The only gives one signal a day at 3:00 am EST or 8:00 am London Time. The indicator is based on the previous Tokyo trading range. So, at the opening of the London trading session, the indicator will indicate whether to go long, short, or stay aside.
A typical London breakout indicator will give you the exact entry level, stop loss level, and take profit level. And you will be able to see all the levels displayed on the chart. You can also create an algo to automate the trading.
London breakout strategy backtest – does it work?
After discussing the theory behind the London breakout strategy, let’s go on to backtest it. Does it work?
To backtest, we must use strict trading rules and settings to avoid hindsight bias. We look at the EURUSD forex pair, and we use the following trading rules:
- We use the high and low from 0300 to 0800 London time to determine the high and low (resistance and support).
- When the price breaks above the high, we go long (between 0800 and 1100 London time).
- When the price breaks below the low, we go long (between 0800 and 1100 London time).
- We use a time exit (no stops or profit targets) at 1200, 1300, 1400, 1500, 1600, and 1700 London time.
Let’s look at the results for the different time stops when we enter long on a breakout above the high:
The first row shows when we exit at 1200, and so forth until 1700. As you can see from column 3, the strategy loses money. Thus, it makes sense to fade the breakout.
Let’s flip the strategy, and buy any breakouts below the low:
The performance, statistics, and metrics are not good. They are better than when it breaks above resistance shown in the first backtest, but column 3 shows that the average gains are hovering around zero.
Thus, the London breakout strategy needs a lot more parameters or risk management to make it work for the EUR/USD pair.
We are skeptical, though, about the performance of this strategy, no matter the forex pair you are looking at.
The EUR/USD pair is very difficult to trade, never mind that forex trading (in general) offers close zero trading edges. There are better opportunities in stocks and bonds, for example. We believe stocks offer a much better risk and reward, and any trading strategy will likely last longer.
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