Breakout is a stock price movement outside a defined support resistance line with increased volume. A trader enters a long position when the stock price breaks above the resistance line.
He/she exits the trade once the stock price moves back inside the resistance line. When the stock price breaks below the support line, he/she enters a short position and sells the shares.
Breakouts occur in all types of markets. Price patterns are usually the cause of breakout activity. Volatility contracts during this time frame, and then it expands when prices move past the identified range.
Regardless of the time frame, breakout trading is a very effective strategy. This strategy can be applied to day trading, swing trade, or any type of trading.
Why Are Stock Breakouts Important?
Breakout traders are looking for stocks that approach $100 multiple times but never reach it. These stocks are likely to continue rising until they reach $100. Then, they may reverse course and fall back down again. This pattern is called a breakout.
A stock that is expected to rise may fall if there is an unexpected drop in demand. An investor who buys shares expecting them to go up may be disappointed when they fall instead.
You can trade stocks by opening an account and using your computer or mobile device. You can also use a demo account to practice before you invest real money.
How To Identify Breakout Stocks
Breakout stocks are identified by finding a market with defined support or resistance level. Once a market gets stuck in an area, various patterns can be used to predict when a breakout might occur.
Head and shoulders, triangles, and flags are some examples of these patterns.
Opening Your Position
A fakeout occurs when a stock moves past its support or resistance level without staying there. This means that the price action is fake and not real.
You should avoid opening positions during these times because you could get trapped into buying or selling too soon. Wait until the price action stays above or below the previous levels.
Volume spikes when the price breaks out. Traders will often wait until the end of a trading day before taking action.
Where To Exit With A Profit
Price targets are based on recent price activity. A recent price channel is often used to set a price target. For instance, if the range of an uptrending channel is six points, then that amount should be used when the stock breaks out above that level.
Price swings are calculated by averaging recent price swings. A 4 point swing means a 50% move up or down. An average of these swings gives you a relative price target.
Where To Exit With A Loss
A breakout occurs after a long period of consolidation. Old resistance levels become new support and old support becomes new resistance.
A breakout indicates a change in trend. Use the old support or resistance as a line in the dirt to close out a losing position.
Exit the trade quickly after a failed trade. Don’t let losses accumulate.
Where To Set A Stop Order
When considering where to exit a trade, use the prior support level as a guide. Set your stop below this level to avoid getting stopped out. Set your stop above this level to avoid triggering an early exit.
This chart shows how an investor should place a stop-loss order when trading stocks. A stop-loss order should be placed below the previous resistance level.
Standard Life Aberdeen
Standard Life Aberdeen had been trading in a range since July 2016. After the merger, the stock broke out of this range.
On 6 February 2018, the stock fell below the 390 level. The previous support area was tested again as a new level of support.
Melrose Industries
Melrose Industries is a company that was once stuck in a range for 4 years. After breaking out, it moved quickly to new highs. A longer consolidation period usually leads to a larger move.
Reckitt Benckiser
A channel is a price pattern that occurs when there is a strong resistance or support line. When prices break out of this channel, it signals a change in momentum.
In this case, the channel was created by the strong resistance at 6500. This channel acted as a barrier to prevent further gains.
Once the market broke out of this channel, the momentum changed and the stock began an upward climb. By placing a limit order at 6600, you were able to profit from the breakout.
Auto Trader
Auto Trader stock broke out above 600 last year, but it didn’t reach the bottom of its channel. Each subsequent low was higher than previous lows.
The top of the pattern remained unchanged, so we had an ascending triangle. This means that Auto Trader stock could be due for another breakout soon.
Auto Trader broke out above its previous high but then turned back down again. This was a fakeout.
Royal Dutch Shell
Head and shoulders patterns are a sign of a trend reversal. This is a good example of how to use this tool.
An inverse head and shoulders pattern occurs when a stock’s price falls after rising to a high point. A bearish trend follows, followed by a second drop below the first low.
This is followed by a rise above resistance. Finally, the price drops below the first low before rising above resistance.
NMC Health
NMC Health hits the upper and lower edge over and over again. Even when it breaks out of the pattern, it loses most of the gains it made before.
Breakout Stocks Summed Up
Stock breakouts occur when a stock’s share price moves beyond a level of support or resistance. These levels are called support and resistance.
When a breakout occurs, traders buy shares because they think the market is going up. Traders sell shares because they think the price is going down. Stock breakouts are used to predict future trends.
Final Thoughts
Breakout trading welcomes volatility.
The volatility experienced after the breakout is likely to generate emotions because prices are moving quickly; using the steps covered in this article will help you define a strategy that, when executed properly, can offer great returns and manageable risk.
