How Does BOS Work in Trading?

What is BOS in trading?

In trading, a Break of Structure (BOS) is a fundamental concept used in technical analysis to identify a critical change in the prevailing trend or pattern of an asset's price movement. It typically occurs when a support or resistance level is decisively breached, signaling a shift in market sentiment. A break of structure can signify the end of an existing trend or the emergence of a new one, and it is often seen as a key entry or exit point for traders.

For instance, if a stock has been consistently making higher highs and higher lows but then breaks below a previously established higher low, it suggests a potential reversal from an uptrend to a downtrend. Traders use BOS to make informed decisions, such as entering short positions when a bearish break of structure occurs or exiting long positions when a bullish trend loses its upward momentum. Recognizing and interpreting breaks of structure is a valuable skill for traders to manage risk and capitalize on changing market conditions.

Break of Structure (BOS) is typically a favorable opportunity for traders to enter positions at a trend reversal with moderate risk, with stop-loss orders often placed at a level that would invalidate the BOS.

Main types of market structure

In technical analysis, there are three classical market structures bullish structure, bearish structure, and ranging structure. These structures assist traders and investors in assessing the current market condition and making decisions regarding their positions.

Bullish Market Structure

In a bullish market structure, prices generally exhibit higher highs and higher lows. This indicates a prevailing uptrend characterized by rising optimism among traders and investors. A Break of Structure (BOS) in a bullish context occurs when the price makes a lower low, signaling a potential trend reversal. Traders often place stop-loss orders below the recent higher low, as a drop below this level could invalidate the bullish trend.

Photo: A bullish market structure

Bearish Market Structure

Conversely, a bearish market structure is defined by lower highs and lower lows, signifying a predominant downtrend. In this scenario, a BOS manifests when the price forms a higher high, hinting at a potential trend reversal. Traders typically position their stop-loss orders above the recent lower high, as a breach of this level could negate the bearish trend.

Photo: A bearish market structure

Sideways (Ranging) Market Structure

In a sideways or ranging market structure, prices move within a horizontal range without forming clear higher highs or lower lows. BOS identification in this context can be challenging. Traders often look for a decisive breakout above or below the range boundaries to spot potential trend shifts. Stop-loss placement in a ranging market often involves setting orders just outside the range to mitigate losses in case of a false breakout.

Photo: A sideway market structure

How to trade a break of market structure (BOS)

This step-by-step guide outlines how to trade breakouts of market structure, helping traders identify and capitalize on trend reversals.

• 1

  Identify the market structure
  Determine the prevailing market structure, which can be bullish, bearish, or ranging. Look for higher highs and higher lows in a bullish trend, lower highs and lower lows in a bearish trend, or a horizontal range in a ranging market

• 2

  Locate the break of structure (BOS)
  Identify the critical point where the market structure is about to change. In a bullish trend, this might be a lower low; in a bearish trend, it could be a higher high. For a ranging market, watch for a decisive breakout above or below the range boundaries

• 3

  Confirm the BOS
  Use technical indicators like Moving Averages, Relative Strength Index (RSI), or MACD to confirm the BOS signal. These indicators can provide additional insights into the strength of the trend reversal

  Also, the identification of a Break of Structure is significantly strengthened by the confirmation from both volume and price action:

  • Volume plays a pivotal role; an increase in volume concurrent with a BOS suggests that a greater number of market participants are committed to the new price direction, thereby lending credibility to the breakout. This is because higher trading volume typically indicates more significant interest and momentum, which can help sustain the move beyond the structural level that has been breached. Conversely, if a BOS occurs on low volume, traders should be wary as it may indicate a lack of conviction behind the move, raising the suspicion of a potential false breakout where prices may revert back to the previous trading range.

  • Price action confirmation techniques further enhance the reliability of a BOS. Traders often look for follow-through movements post-BOS as a sign that the breakout is valid. A follow-through movement occurs when prices continue to move in the direction of the break in subsequent trading sessions, demonstrating that the market has accepted the new price level. Without this confirmation, the initial breakout could be questioned, and the risk of a false breakout increases. Effective price action confirmation not only provides validation for the BOS but also offers traders more solid ground for making informed decisions on entries, exits, and the management of their trades.

• 4

  Entry point
  Once the BOS is confirmed, consider entering a position in the direction of the anticipated trend reversal. For example, if it's a bearish BOS, consider shorting the asset

• 5

  Stop-loss
  To manage risk, place a stop-loss order just beyond the point that would invalidate the BOS. In a bearish BOS, set the stop-loss above the recent higher high; in a bullish BOS, place it below the recent lower low

• 6

  Take profit
  Determine your profit target and the risk-reward ratio before entering the trade. Decide when to take profits or adjust your stop-loss as the trade progresses

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