If you are wondering how to take advantage of early trade opportunities, then breakout trading may be a strategy to add to your trading arsenal!
Seeing and taking advantage of early trade positions requires a plan. Trading breakouts can provide a way to spot these early trade opportunities and provide an ideal entry point.
Using a breakout trading strategy can benefit all types of traders. Whether you are an intraday trader, placing trades daily, or a swing trader, placing trades for days or weeks, using a breakout strategy can be profitable. Even long-term investors can utilize breakout information to their advantage.
Generally speaking, many traders find trading breakouts to be a simple strategy. This article will touch on some specifics so you will have a better idea of when breakouts occur and how to use the breakout trading strategy to enter trades and exit trades.
What is Breakout Trading?
Breakout trading is considered a form of momentum-based trading. A breakout occurs when an asset’s price breaks either levels of resistance or levels of support on a price chart. Support and resistance levels are the core principle of trading breakouts.
Breakout trades tend to involve quicker price moves, higher than average volatility, and demonstrate overall market momentum.
Breakout trading can be used in any time frame and with any trading style.
Day traders looking at intraday charts rely heavily on price action and technical analysis. Spotting price breakouts and determining a valid entry point can allow a trader to open a trade position and take advantage of the high volume and price action early on in a new trend.
Breakout Trading: Support and Resistance Levels
Support or resistance levels are the keys to trading breakouts and are created by historical market data. They are specifically developed by past price points being retested and hit multiple times.
Support and resistance levels demonstrate that either support exists, and pricing will bounce back up or resistance has been met and price action will decline. That is until it doesn’t, and a price breakout occurs.
The idea behind support and resistance is that the more they are respected, the more significant they are. Yet, at some point, the stock breaks these levels due to strong selling pressure or strong buying pressure. Who wins out? The bulls or bears?
Identifying support and resistance and noticing when the market breaks these defined levels can provide an opportunity to open a trade position early on in a new trend. To spot support levels or resistance levels, look for trend lines that develop and price chart patterns.
These patterns can be flat or sloped and present as channels, triangles, flag patterns, and pennants. A chart pattern that contains an area of consolidation or a tighter price range tends to demonstrate levels of support and resistance being formed.
When breakout trading, traders should take note of three important dynamics before implementing a trade: support and resistance levels, overall market trend, and confirmation using volume or another form of technical analysis.
Draw Support and Resistance
Once you spot levels of support and resistance, document them by drawing the resistance level and support level. Seeing it visually will help you determine how many touches the levels have endured, and the length of time the price range has been respected.
High probability breakout trades are ones where levels have been retested numerous times and for a longer time frame. It’s like winding a jack-in-the-box toy up, if you know what that is! If not, just watch the movie “Elf” when Buddy hasn’t been as productive as the other elves and is sent to test out the toys for defects. Seriously, a good holiday movie!
During the period of accumulation, trading volume will be lower. Price action will bounce between the resistance line and significant support. A breakout trader will be specifically waiting for volatility to enter and those levels to fail.
When price action moves outside the previously determined level of support or level of resistance, a trade entry presents.
Overall Market Trend
It is important to take note of the overall trend for the financial asset you are trading. This can support a possible continuation breakout aligned with an existing trend. It can also support a bearish or bullish reversal.
Take for instance, if the market is in a bullish upward trend and resistance levels are flat, and support levels are diagonal creating higher lows, the likelihood of a breakout above resistance and trend continuation may be present.
Seek Confirmation of the Breakout
Not only is price break key when trading breakouts, but volume to support the new price action is also an important consideration. Having volume behind the move makes the breakout trade more significant.
Another factor to enhance the breakout trading strategy is the use of technical indicators. Using an indicator such as the RSI, a momentum oscillator that depicts overbought and oversold conditions of an asset, can help determine reversal breakouts.
For example, if the market is consolidating, and we see levels of resistance being retested and respected, looking at an indicator such as the RSI may also convey an overvalued market condition. This could signal a valid reversal once support is broken.
Entering Breakout Trades
There are a couple of ways to determine your entry point when trading breakouts.
1) Enter a trade breakout once the price closes above the resistance level or below the support level.
If you desire to trade breakouts as they initially develop, this is how most traders who trade this type of momentum strategy do it.
Once the value breaks support or resistance levels and closes, they enter. This allows a trader to get in early on the new price action and maximize the use of high volatility and price momentum.
The downfall of day trading breakouts with this strategy is that you could fall victim to false breakouts. A losing trade will happen.
To ensure you implement high probability breakout trades, seek other means of confirmation like above-average volume and another supportive technical analysis tool before entering your position.
2) Enter the trade once the price breaks above support or resistance and then retests that same level.
If your trading style is to be more conservative, if your personal circumstances mean more implementation of risk management tactics, using this method of entry may be more your style.
Once the price breaks out of support or resistance, wait for the first pullback and the retest. Once the value retests that same breakout level, enter your trade position.
The downfall of this strategy is that the retest doesn’t always happen, and you miss the move and the momentum behind the initial breakout. As always, seek confirmation of the move to protect the capital in your trading account.
Exiting Breakout Trades
Knowing your exit points is just as important, if not more important, than entering a trade. All traders need to plan when they will exit a losing trade and when they will remove themselves from a winning one.
One of the benefits of entering a breakout trade is having a stop loss that is close to your entry. Breakout traders place their stop loss at the base of their entry or just below it.
This creates a low risk to possible reward ratio. Having a stop loss close to your entry reduces the amount that can be lost on a false breakout compared to the possible gain of a real breakout.
Determining profit goals is necessary as well. Using the value range of the support and resistance channel or area of consolidation for a take profit goal is one suggested way of exiting your trade with profit.
If the trade continues to go in your favor and then starts consolidating or creates a fresh supply or demand level, it may be time to exit with your money in hand!
Remember, the market is an unpredictable place! Be strict with your entries and flexible with your expectations!
Summary: Breakout Trading
Trading breakouts can be a great way to take advantage of market volatility and get in early on new price action. Using a defined support or a resistance level to determine a breakout in value is the key principle of the breakout strategy.
Remember, false breakouts can occur, which is why a trader should avoid trading breakouts of above-average volume that don’t exist or if unsupported by other technical factors or indicators. A failed breakout is inevitable, so set your stop loss and get out accordingly.
Practice trading breakouts by paper trading or simulation to gauge your ability to analyze the market atmosphere and produce winning trades. Practicing is a great way to improve your trading skills and learn good risk management habits.
Maurice Kenny has helped over 600 people become financially free through one-on-one coaching, mentorship, and options trading strategy. Many of these new traders are now full-time traders, and they all started by watching his 1-hr webinar.
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