Setup 1: Breakout and retest

The breakout-and-retest is the setup that uses a level flipping (Module 3, Lesson 4) and a BOS (Module 4, Lesson 2) together. It exists because a level that breaks does not stop mattering; it changes sides, and the retest is where the new trapped group shows itself.

The sequence

1. A level exists: a swing high, a range top, a prior day high.
2. Price closes beyond it on the trading timeframe. Not a wick; a close.
3. Price returns to the level from the other side. This is the retest.
4. A candle forms at the retest showing the level holding as its new role (a hammer, a bullish engulfing, or simply a close back above the level after a dip into it).
5. Entry with the candle, stop beyond the retest low, target at the next level.

                                              |
                                            +---+
                          |               +---+ |
                        +---+     |       |   | +---+
                        |   |   +---+     |   |
  49.50 ----------------|---|---|###|-----|---|---------
  zone  ////////////////|///|///+---+/////|///|//////////  <- was resistance, now support
  49.20 ----------------+---+-----|-------+---+---------
             |            |       |          |
           +---+          |               retest (day 5)
       +---+ |
       |   | +---+
       +---+
    day 1   2     3     4     5     6

Who is trapped, and when

Before the breakout: shorts who sold the zone on days 1 and 2 expecting the swing high to hold.

At the breakout (day 3): those shorts are now losing. Some cover into the breakout (fuel for the move); some hold and hope.

At the retest (day 5): price returns to 49.10-49.50. The shorts who held now have a chance to exit near flat, and many take it; that is buying. The breakout buyers from day 3 who were shaken out on day 4 get a second chance at the level; more buying. New buyers who wanted the level before the breakout and missed it are here too. The level has a fresh group defending it from below.

The trap is set the other way, too. Anyone who shorted the day 4 pullback expecting the breakout to fail is now trapped by day 5's close back above the zone. Day 6 squeezes them.

Key idea: The retest is where the shorts who were trapped by the breakout exit, the buyers who missed it enter, and the traders who faded the breakout get trapped. Three groups, all buying at the same zone, is what makes it a level.

The entry candle

At the retest you need a candle that shows the level holding. Acceptable:

• A hammer or bullish engulfing whose wick or body dips into the zone and closes above it (day 5 is a modest version: low 49.10, close 49.95).
• A close back above the zone after a candle that closed inside it.
• On the entry timeframe (one step down), a CHoCH up: the pullback's minor downtrend prints a higher low and closes above its last lower high.

Not acceptable: a candle that closes below the zone. That is a failed breakout (Lesson 3) and a different setup in the opposite direction.

Entry, stop, target

Using the example, with average daily range 1.10:

• Entry: 50.00, the open after the retest candle (or a break of the retest candle's high, 50.10, for confirmation; this course uses the break).
• Stop: below the retest candle's low, plus a buffer. Retest low 49.10, buffer 20% of average range (0.22): stop at 48.88. Below the stop the level has failed as support and the story is false.
• Target: the next resistance. If the prior swing high above is at 52.20, that is the first target.

Reward-to-risk:

• Risk = entry − stop = 50.10 − 48.88 = 1.22
• Reward = target − entry = 52.20 − 50.10 = 2.10
• R:R = 2.10 ÷ 1.22 = 1.72, or 1.7R

That is an acceptable setup. Whether it is a good one depends on the win rate you have measured for this setup in this market (Module 6). Lesson 4 covers the arithmetic that connects the two.

Variants and timing

• Fast retest (one to three candles after the break): common and clean. The breakout was strong enough that the market barely paused.
• Slow retest (after a period of consolidation above the level): the level has aged but the trapped shorts are still there; still valid.
• No retest: price breaks and keeps going. You miss it. That is the correct outcome; the setup was not offered. Chasing a breakout without a retest means entering with no defined stop level and a worse R:R.
• Retest that overshoots: the retest wick goes deeper than the zone but the close is back above. A deeper wick means more shorts trapped; the setup is stronger, but the stop is further away and the R:R worse. Compute it.

Where this setup fails

• Range tops. The first breakout of a range fails more often than not (Module 4, Lesson 3). A breakout-and-retest at a range top needs the context timeframe to be trending in the breakout direction, or it is a failed-breakout candidate.
• Thin markets and news candles. A breakout on a news spike is often fully reversed; the retest becomes a breakdown.
• Late in a mature trend. The eighth BOS of an uptrend has a small trapped-short group (nobody is shorting anymore) and a nearby resistance. Poor R:R.

Try it: Find ten completed breakout-and-retest sequences on a daily chart (breakout close, return to the zone, candle at the zone). For each, compute the entry, stop and target as above and record the R:R. Then record whether the target or the stop was hit first. Keep this; it is the seed of the Module 6 backtest.

Recap

• Sequence: level, close beyond it, return to it, candle showing it holding, entry.
• The retest is where trapped shorts exit, missed buyers enter and breakout-faders get trapped: three groups buying at one zone.
• Entry on a break of the retest candle's high; stop beyond the retest low plus a buffer; target at the next level.
• R:R = (target − entry) ÷ (entry − stop). Compute it before entering, every time.
• No retest means no trade. Range tops, news spikes and mature trends are where the setup is weakest.