Setup 1: Breakout and retest

The breakout and retest is the first setup most price action traders learn, because it combines three things you already know: a level that has held (Module 4), a break of it with volume (Module 5), and the flip of the level on the retest (Module 4, Lesson 3). The retest is where you enter. This lesson goes through it end to end.

Context

You need a level that has rejected price at least twice. A range ceiling, a prior swing high, a prior day high with confluence. The more times it held and the more obvious it was, the more traders are watching it, and the bigger the crowd that gets trapped when it breaks.

Then you need the break: a candle that closes beyond the level, ideally on volume above average. A wick through the level with a close back inside is not a break; it is a failed break, which belongs to Setup 3.

You do not trade the break itself. Beginners buy the breakout candle, get filled at the worst price of the day, and get shaken out when price comes back to retest. The setup begins after the break, when price returns.

The retest

Price pulls back toward the broken level. On a healthy retest, volume is lighter than on the break, the candles into the level have small bodies, and the reaction at the level is visible: a wick below it, a close above it, or an engulfing candle turning back up. That reaction is the entry trigger.

                                                            +---+
                                                          +---+ |
         target  -------------------------------------  +---+     next resistance
                                                      +---+
                                                    +---+
                                                  +---+
         entry   ----------------------------- +---+   <- close back above level
                                       +---+ +---+
         level   ----|----|----|-----+---+-|-+---+--------  old resistance
                     |    |    |   +---+   +---+
                   +---++---++---+ |         |   <- retest wick
                   |   ||   ||   |+---+
                 +---+ +---+ +---+
                                     ^
                                   break on volume
         stop    --------------------------------|--------  below retest wick

 volume            ##   ##   ##   #####  ##  ##  ###
                   ##   ##   ##   #####  ##      ###
                             ##   #####          ###
                                  #####

Entry, stop, target in numbers

A stock with a range ceiling at 30.00, tested three times. Average daily volume 1.2 million.

• Entry: 30.60, at the open of day 5, after day 4 closed back above the level with a rejection wick. Some traders enter at day 4's close (30.50); either is fine as long as you wait for the close.
• Stop: 29.60, below the retest wick at 29.80 with a small buffer. If price closes below the retest low, the flip has failed and the breakout buyers are the trapped ones.
• Target: the next resistance. Suppose the prior swing high above the range is at 33.50. Target 33.40, just under it.

Risk = 30.60 - 29.60 = 1.00. Reward = 33.40 - 30.60 = 2.80. R:R = 2.8. Good enough to take.

Key idea: Do not buy the break; buy the retest. The trigger is a candle that reaches the broken level and closes back on the breakout side. The stop goes beyond the retest wick. The target is the next level in the breakout direction. If the retest closes through the level, the break has failed and you have no trade.

When it fails and what that looks like

The retest slices through. Instead of a wick and a close above, you get a full-bodied candle closing below the level, often on heavier volume. That is the defenders winning and the breakout buyers being trapped. Your stop handles it; that is what it is for.

The retest never comes. Sometimes a breakout runs without pulling back, especially on strong news. That is a missed trade, not a failed one. Chasing it means buying with no nearby level for a stop. Let it go; there will be another.

The retest is messy. Price wobbles around the level for several days, closing just above, then just below, then just above. That is a range forming on the level, not a clean flip. Wait until it resolves. A close well above the highest wobble is a late but valid trigger.

Grading the setup

Before entering, score these:

You do not need every box in the better column. You should not take the trade with most of them in the worse column.

The short version

Everything flips for a downside break: a support level that held at least twice, a close below it on volume, a retest up to it, a rejection candle closing back below, entry on that close, stop above the retest wick, target at the next support below.

Try it: On a daily chart, find three breakouts of a level that held at least twice. For each, record: was there a retest, did it hold, what was the reaction candle, and what R:R was available to the next level. Then find two breaks that failed on the retest and look at what the retest candle looked like. You are building a mental library of the two outcomes.

Recap

• Context: a level that rejected price at least twice, then a close beyond it, ideally on volume 2x average or more.
• Entry: after the retest, when a candle touches the level and closes back on the breakout side.
• Stop: beyond the retest wick with a small buffer. A close through the level means the flip failed.
• Target: the next level in the breakout direction. Require an R:R of roughly 2.5 or better.
• Do not chase the break itself or a breakout that never retests; wait for the next one.