Breakout strategies are momentum based - that is, they are long when momentum is strong and a stock is trending, however, they differ from pure momentum strategies in that they wait for some form of consolidation and a subsequent break from that consolidation to confirm that the trend is continuing before entering. A breakout is when price moves above a resistance level (or below a support level if the prior trend is down).
Breakout strategies can include:
- breaks from patterns such as triangles, flags or ledge patterns (usually forming over a period of days to weeks)
- breaks from patterns such as cup and handle, box and basing patterns (usually forming over a a period of weeks to sometimes months)
Trades can be taken from daily or weekly charts. The following is an example of an ascending triangle breakout trade. The top of the triangle formed resistance at $8.40 and the pattern formed over only 11 candles. Price made higher lows leading up to the break before finally breaking through the resistance level.
Breakout strategies might suit people who:
- are traders or investors - remember, patterns form in all time frames so this strategy can work for longer term investors
- have the patience to wait for a pattern to form
- don't mind stops a reasonable way away from entry
- have the capacity to enter a trade even when higher prices are being made
- don't have time to sit and watch the markets all day - conditional orders can be placed to enter if certain criteria are met
- can visually recognise patterns on a chart - this approach can be subjective as not everyone will recognise or use the same patterns or support or resistance levels.
Let's take a closer look at a breakout trading strategy and how to develop a trading plan to capture these trades.
| Trading Premise | The path of least resistance for stocks that are already trending is to continue in the same direction as that trend after a period of consolidation. Price tends to move in cycles from trending to consolidation to trending so if a period of consolidation can be identified it can provide a sound trade setup indicating entry, stop and target prices. |
| Setup | A consolidation pattern that forms over X days or X weeks (depending on your time frame) |
| Entry | Buy on a break of a resistance level only if supported by an increase in volume - breakouts with relatively high volume show interest and price is more likely to continue to trend, breakouts on low volume can be more prone to failure |
| Stop | Stop to be set 1 or 2 cents (or more if the stock is higher priced or the trade is longer term) below the low of the pattern |
| Target | Targets can be determined by: 1. a proportion of the measure of the trending move prior to the pattern formation 2. the height of the pattern added on to the breakout level 3. a logical price point above price action such as below a gap or below a longer term resistance level |
| Trade management | Options to consider:
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