“Breakouts and breakdowns attract many participants but require precise timing to turn a profit. Insiders know that these hot spots attract dumb money. They initiate whipsaws after each volume surge to shake out weak hands. This ensures that the majority enters positions just as the market reverses.” Alan Farley.
Breakout occurs when a stock clears a price level that for whatever reason has been a virtual cover on the stocks advance. Stock chart readers recognize it as the moment when a stock has thrown off that cover and has the greatest probability of making meaningful gains. Some stocks double in price in a matter of few months.
Breakout stocks are stocks either rallying to a new high or into a price area with no resistance. Breakout stocks typically break through a resistance area and rally quite quickly to a new higher price area.
All breakouts are questionable until they follow through. A perfect breakout is a clean breakout. Most stocks tend to retest their breakout points a number of weeks into their breakouts. When they do this they offer some of those investors who are tracking its movements for a second chance to jump in. A clean breakout stock does not even come close to its previous resistance line. Weeks after a breakout, statistically, a considerable number of stocks do retest its support line. They can breach the support line but should not close below the line.
For a successful and impressive breakout the stock needs to be trading above its 50 day moving average and 50 day moving average above its 200 day moving average. Not all breakouts are from Cup-With-Handle base formations. Stocks that successfully retest their resistance level usually rebound forcefully to fresh new highs.
One form of breakout is called “Continuation Breakouts”. Continuation type breakouts are typical on up trending momentum stocks moving to new highs. The resistance the breakout breaks through is usually a weaker type of resistance. For example, stock makes a new 52-week high around $151 and then pulls back 3-5 points. Then it starts rising again and breaks price point of $151 with volume. This is considered as Continuation Breakout.
True Breakouts erupt from double and triple strong resistance and can have strong quick rallies. The strongest pattern being a sliding upward flat top. The price range at the top is supposed to be very narrow.
Higher quality breakouts (fast and big move) usually occur for flat top breakouts with longer top consolidation periods (1 week to 1 month in time frame). Flat top breakouts usually allow for tighter breakout stop limits enabling higher quality profit/loss trades.
When stocks breakout after strong rally then it is possible the stock may not go further up as the move has already taken place. During the day of the breakout the volume has to be very high.
Trader should be cautious on breakouts that occur on earnings or news events (upgrades). These can cause false breakouts. Some of the better breakouts usually occur when there is no news. Therefore, traders should be capable of recognizing the failed breakouts and should get out of the trade immediately. The initial loss is the best loss in this case as any hesitancy can result in disaster. Some price action can indicate that a retest is way underway while in the background that very price action was the beginning of a sell off and eventual price breakdown; with a close below its important support line. We also need to be cautious on breakouts after a previous rally. While breakouts do occur their profit may be less and stop loss may need to be higher.
Trader should master the breakouts with unwavering execution. Some of the best breakouts can be found by making a list of breakout candidates prior to the actual breakout and then watch for the abrupt upward stock movement to trigger an entry point. I monitor breakout candidates like a hawk and when it starts trading above the important resistance line and volumes starts increasing and meet my minimum criterion that’s when I enter the trade with half lot. Once the stock establishes itself as successful breakout then I add another half to my position. Sometimes we all have the urge to cheat a little bit and enter prematurely into the breakout, thinking that if a stock is eventually going to breakout then why not buy it at low price. This is not disciplined trading rather trading with greed. If a breakout is going to happen then the gain will be enormous so it is advisable to wait for confirmation of the breakout.
Be cautious on breakouts after a previous rally. While breakouts do occur their profit may be less and stop loss may need to be higher.