Breakouts are a very talked-about topic in trading but we see that they are also very much misunderstood. Many traders jump into a breakout trade thinking they are going to see large movement, but instead, what they find is that the price stalls out or reverses within minutes. This in turn causes frustration for the trader and they begin to question what quantity to put in, at what point to book profit, and whether it better to hold or cut loose early.
In fact, what we find is that these decisions do not have to be so hard once you put one thing into perspective not all breakouts are the same. Some are very strong and reliable, while others are not at all and can mislead.
Definition:
A breakout is when the price action goes past what is a key support or resistance level and begins to trade out of the previous range. That move also indicates which side buyers or sellers are taking over.
A strong breakout is when the price stays above (or below) the level and continues to move in the same direction with no hesitation. In contrast, a weak breakout has trouble sustaining itself above the level and also tends to reverse. To better identify which is which is key to improving your trade consistency.
Significance
Breakout reports are few in number; what we see is of those that don’t materialize. On charts these failed outages may look presentable, but in reality have little to no following; the price movement is short lived. Traders who jump into these are usually the ones left out.
By looking at which breakouts occur and how prices act post-breakout, and also by identifying when they happen in the trading session, traders are able to filter out low-quality trades. This in turn helps reduce false entries and keeps emotions in check especially in fast-moving markets.
Importance
Breakout strength is a key element in risk management. When we see a strong breakout traders may put on longer-term trades which will not be short-lived. On the other hand we have weak breakouts that act as a cautionary signal.
This knowledge in turn allows traders to determine which of the options to trail stops, reduce position size, or get out of the trade completely. Also, over time, this results in more disciplined trading and less impulsive decisions.
Usage
Breakouts analysis is used in intraday and short-term trading. Traders usually look at three basic yet very important factors:.
- How the breakout happens: In the past a sudden change we have seen to be healthier when it comes out of a quiet start as opposed to a large gap.
- Price behavior after the breakout: Strong trends hold their ground, weak ones reverse quickly.
- Timing of the breakout: Later in the session we see more reliable results as compared to early morning spikes.
- If a stock gaps up beyond resistance, many experienced traders will reduce position size or wait for confirmation. Out of consolidation which then breaks out slowly and steadily, tends to work better.
Examples
We assume that a stock has a key resistance at 1000.
In the event the market opens at 1000 and then slowly goes past this level with steady buying support we see that as a sign of strength. That which we are seeing is that buyers are putting in support and pushing prices up.
Also, should the stock open at 1020 or 1030, the situation is riskier. In that case early players may start to book profits and we see selling pressure as well as a lack of follow-through.
Another warning is when we see prices go above 1000 only to correct back down by over 50% of that move. Such large corrections usually point to weak demand out there and also increase the chance of a reversal.
Timing is a key factor. What we see are breakouts that sustain through the end of the trading session or at market close which in turn usually indicate real strength, as they are supported by consistent action instead of short-term volatility.
Benefits
- Helps identify more reliable breakout opportunities
- Supports better position sizing decisions
- Reduces risk of false breakouts.
- Encourages patient and disciplined trading
- Matches well with price action and volume analysis.
Disadvantages
- Requiring regular screen time and market observation.
- Can at times be less effective during rapid movements in the news.
- Demands emotional control and patience
- Even at times, strong-looking breakouts fail.
Conclusion
Determining at what degree a breakouts is strong or weak is not just a matter of adding indicators to a chart. We look at price action as it relates to key levels and try to read the market’s intent. By looking at structure, confirmation and timing we are able to filter out what is irrelevant noise and in turn make better informed decisions which in the end reduces avoidable losses.
Through consistent practice and proper risk management breakout analysis is a tool for long term trading success which doesn’t have to be a short-term fix.
Disclaimer: BFM Times acts as a source of information for knowledge purposes and does not claim to be a financial advisor. Kindly consult your financial advisor before investing.
