Understanding Breakout Trading

by Josh Biggs in Finance on 6th May 2022

Have you ever heard of breakout trading?

Or have you ever traded during a breakout moment?

Maybe you’ve been in a situation like this:

You see the price has broken through resistance, very bullish. You dive in, come into play. However, soon the price reverses direction, even though you just bought high.

The example above is a situation that is not desired by all traders. Therefore you must understand how breakout transactions work in order to achieve good results.

Keep up with Finex article and discover how to implement a breakout trading strategy. Whatever your trading style, this strategy can be applied to the fullest if you really understand it.

Understanding Breakout Trading

We investors cannot be separated from observing activities, whether observing price movements or for technical traders, observing possible trends that will occur. As traders or investors who are actively creating opportunities, we take the time to do analysis.

A breakout occurs when the price moves past a certain level, so a breakout can be interpreted as a potential trade where the asset price moves significantly through a resistance level or moves below a support level.

When you trade on that momentum, you make a breakout trade.

Breakouts occur quite often in stock instruments, but technical traders can also find them in commodity assets and Forex.

Type of Breakout

There are two types of breakout, namely:

1.           True Breakout

The original breakout, which actually happened. When the price breaks the critical level, it will continue in the direction of the breakout. Before making a decision to follow it, be careful by studying trading in the true breakout moment and risk management to stay safe.

2.           False Breakout

Fake breakout, didn’t happen as expected. After the price breaks the critical level, it moves back in the previous direction and tends towards it. General experience shows that false breakouts occur quite often in the market.

Identifying Breakout

Simply put, if a market looks very bullish, it is usually too late to enter.

What you have to do when you find a potential breakout is to identify a price trend pattern along with support and resistance levels in order to be able to make an entry and exit plan.

Active traders and investors often use breakouts to identify trends that are still in their early stages. Breakouts are often followed by price action and repeated volatility, making it a promising field for profit.

For example in stock trading, if a stock reaches the level of $100 for several times but always reverses direction, we can wait first to buy because it could be that the movement does not promise a return. However, if a stock crosses $100, we can see it as a sign to buy. Owners of these shares who are in short position may be tempted to sell to cover their losses. At the same time, a situation where higher demand will push stock prices to continue to rise and become a new trend.

An easy way to identify a breakout is to observe the state of the market that is “sandwiched” in the channel between the support and resistance levels – often referred to as consolidation. The more often the price touches this zone, the more valid the potential breakout is.

Long periods of consolidation are often associated with large breakout. An instrument that is traded over a significant period of time will experience greater movement than one that has only consolidated over a few weeks.

How to Trade During Breakout

You need to pay attention to a number of important things to be able to trade successfully at the breakout moment.

1.           When opening a position

If you are sure that a breakout will occur, it’s time to plan when to open a position. Get in the habit of watching for possible false breakouts. You need patience to avoid fake breakouts. No need to rush to open position when prices break new levels. Better watch the movement first. A massive increase in transaction volume can be seen as a real breakout.

2.           Planning time out

This is an essential step. As part of risk management, you need to determine when is the right time to take profit from profitable position and when to stop loss if the trend fails to materialize. Using stop order at or around the previous support or resistance level can prevent you from losing when the breakout fails to occur. A sign of a successful breakout is that the previous support level often becomes a new zone of resistance and the previous resistance level becomes a new zone of support.

In the end, you should always have a plan. If we fail to plan, we plan to fail. Breakout trading is one of the strategy that you must know to add insight so you can see the opportunities that will come.

You can do breakout because you are familiar with it, so you can start from the identification stage, waiting patiently, setting realistic target, to planning out. As much as possible avoid emotional interference in decision making. Always think clearly in the face of volatility to get great returns and minimal risk.

Categories: Finance