The Profit Potential of Breakout Patterns
Breakout patterns are defined by a clear stage of accumulation. This is when price will have a continually rising and falling pattern, but the stock will keep hitting a price where it can "breakout of" and the stock will keep making higher lows making a tighter channel. We screen for particular criteria in order to catch stocks that are in this accumulation phase before they are able to breakout. Once the stock has enough momentum, usually from a big piece of news or earnings, it will break through this area of resistance. The profit potential is very high on this type of trade, but we will help you know when to get in and get out of these trades.
How to trade a Breakout
So as stated in the paragraph before breakout patterns are defined by a clear stage of accumulation. This accumulation is often at least a month period to confirm that the points of resistance and support are easily defined. In the illustration to the right you can see a clear breakout pattern. Prior to this illustration there was a strong uptrend. Then price hit a certain point where it pulled back. In this demonstration that point is the white line through the top third of the chart. After hitting that point price drops, but it is important to note that price didn't drop nearly as far as it climbed in its last uptrend. After the drop price halts for a moment and then it begins to climb again. After this climb it then hits our top resistance point which confirms the point of resistance. so when price then drops again after hitting it and then immediately pulls back after hitting the 15 exponential moving average. The third time we see price hit our resistance point price is able to finally breakout above our resistance point and make higher highs.
Now that you understand how the breakout works, you need to know where you would take a position. This part is easier said than done. Price can be very volatile at times, even when the underlying stock doesn't have anything happen to it. This can be caused by news in the overall market, a competitors earnings, or really anything. So knowing when to enter and exit a trade is going to be your key to success in the stock market.
So where is that we enter and exit? Many people believe that you should buy before the initial breakout in order to capture a breakout if one occurs. Others think that it is important to wait for the first initial pull back after price has broken out. Honestly though there are different scenarios that suit each of these strategies so we say why not use both. When we think that a stock has a higher chance of breaking out then we will give you buy points that are before the stock breaks out and we will give varies options positions that will give you a hedge on your position. If we are more skeptical on a breakout we will wait until price either pulls back to a previous point of resistance or an exponential moving average. So now that you understand how we will alert you to entering the market it is now time to go over exiting.
Exiting the market is much more psychological then anything else. This is mainly due to the fact that peoples addictive habits come in to play when selling a position. Someone may have an option that has had its premium double in only two days. Instead of possibly selling part of their position so they can lock in a gain they decide to hold the entire position for a few more days in the hopes of a higher ROI. We take the psychology out of trading by using previous points of support and resistance to indicate when you should sell. Having clearly defined profit taking points takes the guessing game out of when to sell.
Now that you have an understanding of how breakouts work, you can trade them with confidence. Be sure to review this information periodically and check out our blog and different trading strategies to learn more about the crazy world that is the stock market.