What Is Price Breakout?
Traders who use technical analysis often develop trading strategies based on the levels of support and resistance of the stock price. But some traders build their trading based on breakouts of support or resistance levels.
Price Breakout Definition?
It is what happens when stock prices (or prices of any other asset class) exceed the previously defined levels of support or resistance. Long positions are triggered when prices move above the resistance level, while short positions receive signals when prices fall below a well-defined support level. Since these breakouts are rare and unexpected, other traders in the market are caught off guard by price activity and, as a result, by volatility, which tends to increase. Another reason for this increase is that traders with trading strategies on a range often have stop-loss orders only outside the specified range. And when a breakout executes these orders, prices start moving in the direction of the breakout.
Breakout traders look for strong stocks. They buy when the stock has just made a breakout and follow it up, because high volume breakouts are usually strong buy signals, especially in bull markets.
Breakout traders often have their own set of rules that help determine if a breakout is a false signal or a big purchase. They may decide to add fundamental analysis or other indicators that will help weed out breakouts that generate false signals.
Signals for breakout trades typically occur when volatility increases with prices that grow above their historical ranges. Traders use proper money management techniques to limit the risk and catch significant price movements before all the other traders in the market know about the new developing trend.
Breakout Trading Strategies
During a breakout, a stock price moves beyond a certain level of support or resistance with an increased volume. A breakout trader enters a long position after the price per share breaks above the resistance level and enters the short position after the price breaks below the support level. As soon as the stock starts to trade outside the price barrier, volatility tends to increase, and prices typically move in the breakout direction.
The reason why breakouts are such a valuable trading strategy is that these breakouts are the starting point for future volatility increases and significant price fluctuations. In many cases, breakouts are the starting point for upward price trends.
For a breakout trader, it is important to consider basic levels of support and resistance. The more times the price relates to these areas, the more accurate these levels are, and the more important they become. At the same time, the longer these levels have been in the game, the better is the result, when a price breakout finally occurs.
Price breakouts tend to develop in waves. As a rule, each successive wave is similar to the previous one in the angle of inclination, length, and duration. Traders use these properties to predict how many points this breakout will take. Between sharp drops, the price bars stop and accumulate until the volatility is reduced, and stability is restored. Analysis of positions in these points brings traders great benefits.
Often, the price breakout stops after the first wave, and the price rolls back, coming very close to the support/resistance level. The second breakout attempt provides excellent opportunities for identifying entry points. Even though the profits of breakout traders decrease with price pullbacks, the traders support and also strengthen their positions by opening new ones. Sometimes the price “jumps” back through the barrier, warming up the breakout, and then falls again, returning to the previous range. But if a breakout occurs with a sufficient number of bidders, the price rolls back from the zone of congestion, and the volume falls when you roll back – the traders quickly “jump on board.” The counter-trend will retreat quickly and with little danger.
As a rule, the most explosive price movements are the result of the price being traded in a horizontal channel. In this type of channel, support and resistance levels are most apparent to traders. In this strategy, the breakout traders actually test themselves, in that they set their limit orders above the resistance line or below the support line. When the price breaks through this level, the limit orders are triggered automatically. This leads to an increase in volume.
Breakout Definition Methods
Breakout traders look at stocks that have the following positions:
- The Bollinger lines width index is three, or less, with 20 or more candles.
- The stock has low volume, indicating a “calm before the storm.” Stocks, the volume of transactions for which has fallen, have the highest potential to “explode.”
- The 5-, 10-, or 20-day indicators of the exponential moving average have converged.
- The level of support and resistance is determined.
- A relatively narrow trading range over X units of time is obvious. For example, the program can investigate when the range over seven periods is low relative to recent ranges over seven periods.
- A stock has a specific sequence of bars (three or more) when the market closes within the previous range of bars.
When these areas are found, it is essential that the trader has precise rules for identifying the signal entering the market and managing the trade.
The biggest challenge for traders is taking losses. Instead of selling with a small loss, these traders will hold on to their stocks and continue trading, hoping to close with a profit. But when the sales go up, they will hope to break even. When the action begins to take another turn, they are waiting to reach the break-even point. And when they drop their shares at the highs, this creates a price resistance level. As a result, a breakout of this resistance level is visible, and breakout traders can return to buying stocks at this time.
The key to successful breakout trading is the vision of the subsequent price activity towards a breakout (resistance level for a long trading position, support level for a short trading position). Without this impulse, prices will go in the opposite direction and stop breakout traders outside their position.