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What is Breakout Trading? The Complete Guide

by | Sep 16, 2019 | Forex Trading | 0 comments

Intraday Breakout Trading Strategy and Indicators


Strategy for Trading Breakouts

How Do You Identify A Breakout?

Breakout trading occurs when a stock price moves beyond either an area of support or resistance with an increased volume. Once the price breaks, there is an increase in volatility and an increased chance for the price to trend in the direction of the breakout. This makes breakout trading a good opportunity  as there is an increased predictability in the stock price.

How Do You Filter A False Breakout?

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When breakout trading one of the things you want to look out for is a false breakout. But how to you identify a false breakout?The short answer is simply to wait or look for high volume. False breakouts typically move back within the support or resistance level by the end of the day. High volume is also usually a good indicator to determine whether the price changes are emblematic of a breakout.

After a breakout though, the price will generally first retrace back to the breakout point before trending away once more. This is a result of the short-term trading that can occur during the initial breakout as other traders look to snag some quick profit. As long as the price moves back towards the direction of the initial breakout after this retrace, it is a not a false breakout. This is an important concept for traders wanting to master breakout trading.

How Do You Confirm Breakouts?

The key way to confirm breakouts when breakout trading is to look at volume. Increased volume in breakouts show that there is high interest and conviction in the breakout, which further confirms breakouts and generally precedes a price trend towards the breakout direction. High volume also generally means that “smart money”, or institutional investors are involved. This “smart money” has the power to seize control and drive the asset into bullish or bearish territory.

On the other hand, decreased volume show lower levels of interest and conviction, and the price will be more likely to return to previous levels of support or resistance. Low volume generally shows a lack of “smart money” trading activity. When the “smart money” is not involved, smart breakout trading will avoid generalizing the data in to a trend.

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Breakout Trading Indicators

What Is Price Breakout In Stock Market?

In the stock market, a price breakout occurs when a stock price moves beyond either an area of support or resistance and is usually accompanied by increased volume and volatility. After the price breaks, there is usually increased activity from traders. The price will usually drop back down the the breakout point, but will reverse the drop and will trend back upwards. Breakout trading takes advantage of this scenario.

Breakouts occur in many different market settings, including channels and other patterns like triangles, flags, and head and shoulders.

During breakout trading, increased activity occurs when traders establish entry points or exit out of trades.

How Do You Trade A Trendline Breakout?

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Futures Trading System

Trend line breakout trading can be difficult, as the breakout may be masked by the trend. As such, it is important to first define the trend line. In general, this is a line that maps past highs or lows and projects into the future. In order to define the trend line, it is often useful to use technical indicators to confirm the direction of the trend.

Before breakout trading, you should first confirm the breakout. For a trend line breakout, this can occur in two ways – either the price rebounds from the trend line, or breaks through. Again, breakouts can be confirmed by waiting until the end of the trading period to see if the price has returned to the trend line, or by analyzing the trade volume. High volume is typically emblematic of a breakout and can be a way of confirmation.

After confirming the breakout, an entry point should be established near the trend line to ensure a good price. It is also good to set a tight stop in order to minimize risk in case the breakout fails. Finally, your limit should be set up at least twice as large as the stop to increase your chances of successful breakout trading.

For a more in-depth breakout trading guide on how to trade a trend line breakout, see Rob Pasche’s step-by-step article from DailyFX.

What Is Bullish Breakout?

A long position is a popular position in buy and hold investing, in which a trader buys stocks and holds them for a long time. In breakout trading, a bullish breakout occurs when the stock price breaks above the resistance threshold. Then, as is typical with breakouts, the price will gather volume and volatility, and trend upwards. Traders looking to profit should buy and hold the asset as the price rises, and will typically look to hold a long position.

What Is A Multi Day Breakout?

Breakouts generally occur when stock prices move past established support or resistance areas with high volume. A multi day breakout is differentiated from a typical breakout when this persists for more than a day. This is usually shown through a consistently increased volume of trading, as well as a continued trend in the breakout direction over several days.

How Do You Find Trend Breakout?

The main ways to identify a breakout are time and volume. Real breakout prices will continue to go in the direction of the breakout, while false breakouts will return to levels of support or resistance, usually by the end of the day. Also, high volume is typically a good indicator of a breakout, as it shows increased interest and conviction in the stock from many other traders.

With a trend line, it may be harder to identify when a breakout may be occurring, as the price is already increasing or decreasing significantly over time. What can help distinguish the breakout from the trend line is high volume. Furthermore, although a breakout may return to its initial point after either rebounding or breaking through the trend line, it will continue in the breakout direction afterwards.

How Do You Trade On Channel Breakouts?

Channel patterns typically appear in stock prices that are moderately volatile and have consistent oscillations. It is common, however, for price channels to have temporary spikes beyond resistance and support areas, which may otherwise be a good indicator of a breakout. Again, checking for time and volume may be crucial in recognizing a true breakout when it occurs.

When breakout trading, it is important to confirm the breakout before considering an entry point. For a more in-depth breakout trading guide showing how to trade on channel breakouts, see a video by Day Trading Radio.

How Do You Calculate Price/Volume Breakout?

Price/volume breakout can be calculated by looking at the trends in price and volume in stocks. These can usually be seen in many charting platforms. In a bullish breakout, volume and price are trending in the same direction. When breakout trading for example, price would go up with high volume, and go down with low volume.

How Do You Calculate Breakout Volume?

Breakout volume generally provides a good sense for whether a breakout is true or false. An increased or high volume is typically emblematic of increased interest and conviction in the stock. It also usually precedes a persistent trend in the breakout direction, thus marking a breakout. A decreased or low volume, on the other hand, typically indicates decreased interest and may lead to a false breakout.

Similarly to price/volume breakout, breakout volume can usually be found in many charting platforms. The formulas these charting platforms use are all slightly distinct, so it is important to consider your market approach when looking at volume indicators.

How To Trade Breakouts In Forex

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Forex Trading

Breakout trading in Forex (the foreign exchange market) can be tricky, as you will be unable to see the volume of trades in the market. As mentioned above, volume is commonly used as a good indicator for whether a breakout is true. This makes breakout trading in Forex inherently more risky than in other markets. Fortunately, there are other indicators that can help you reduce risk in your Forex breakout trades.

One of the biggest advantages of breakout trading Forex is the volatility of currency pairs. This can make up for the opacity of volume in the market. A high marker of volatility is large price movement within a short period of time. On the other hand, a low marker of volatility would be small price movement within a short period of time.Generally, currency pairs with low volatility will make for good trades, as they will be more likely to breakout.

General Forex Trading Tips

We delved deeply into breakout trading and how to capitalize on breakouts, but there are several other aspects of trading that can help you make the optimal trading decisions. Only focusing on breakouts is scratching the surface of all possible scenarios a trader has to consider when Forex trading.

At the end of the day, each trade you make is a prediction on how you believe the market will behave in the coming future. Trading on the belief that there will be a breakout is a prediction, and predictions are always more accurate when you have a clearer holistic picture. For that reason, we highly suggest focusing on the fundamentals of trading and doing further research on what other technical indicators to look out for.

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