Breakout trading is popular among day traders and other active investors who are looking for reliable setups or ways to enter a position at the beginning of a trend. Breakouts are frequently the start of major price moves and can give excellent profits with minimal risks if done properly.
What does a Breakout Look Like?
A breakout occurs when the price of a stock or other asset moves outside its prior support or resistance level with an accompanying spike in volume. Once price moves through the support or resistance it’s typical for volatility to increase, giving the trend additional momentum. It’s this tendency towards increased volatility and momentum that makes breakout trades so attractive to traders.
There are many different markets and setups that can provide opportunities to trade breakouts. While basic support and resistance are the criteria, these can occur as part of channels, pennants and flags, moving averages, swing high and lows, and any other formation that provides support or resistance.
The breakout is also popular because it can be used with any timeframe from minute charts to weekly charts. That means traders can use it with any style of trading.
Below are the basic steps to take if you want to trade breakouts:
- Find a Likely Candidate
Identify stocks that have strong support or resistance levels and track them. The stronger this support or resistance the better. Be patient.
- Watch for the Breakout
Just because a stock looks like a candidate it doesn’t mean a breakout will occur. You’ll have to wait and see if it does, and be ready to step in. Remember to watch for increased volume, and large, strong moves.
- Have a Profit Target
Before entering a trade you should also know when you’re going to exit the trade. This might be based on the distance between former support and resistance, or it could be based on the average historical move of the stock.
- Wait for a Retest
This is a step many traders miss out on. Remember that any time a stock breaks support that old support level becomes resistance, and any time a stock breaks resistance that old resistance becomes support. And many times a stock will retrace to test these levels within a few days. Watch for it and be ready.
- Learn to Recognize Failed Trades
When you see a stock retesting the former support or resistance level and breaking through,it means your trade has failed. Exit immediately. Take small losses and let your winners run. Even with a solid breakout strategy you might see as many as 40% of your trades ending as losers.
- Don’t Close Trades at Market Opening
It’s impossible to know what prices will do throughout the day, so many traders prefer waiting until late in the day before exiting a losing trade, just in case there’s a bounce after a weak open.
- Remain Patient
I know it was said earlier, but it bears repeating – be patient! This strategy needs your patience and a quiet mind. Don’t let your emotions dictate your trades.
- Exit when your Target is Reached
If there’s no reason to take a loss on the trade then remain in it until your price target is reached. Do use stops to protect yourself in case the trade goes bad.
Trading breakouts can be a successful way to become an active trader. Have an entry plan, remain patient and follow the plan.Also have an exit plan and you’ll be on the right path to success with breakout trading.