Breakout trading is a popular strategy used to take advantage of substantial price movements when a price surpasses a predetermined level of support or resistance, accompanied by a noticeable surge in trading volume. This strategy aims to capitalize on the momentum generated by the breakout, potentially leading to profitable trading opportunities. Read the article to learn more about the strategy and use it for profit.
How to use it?
Two crucial components of breakout trading are support and resistance levels. Support is a price level where a price typically rebounds after a decline, while resistance is a price level where a price tends to reverse its upward trend. Breakouts happen when the price of an asset moves beyond a resistance level or below a support level with heightened trading volume.
When engaging in breakout trading, it is important to recognize specific price patterns, such as the ascending triangle pattern. This pattern is characterized by a series of peaks that the price has reached but not broken through; this can indicate a potential upward price trend.
You take a long position (buy) when the stock price breaks above resistance or a short position (sell) when it breaks below support. After an asset trades beyond the price barrier, volatility tends to increase and prices usually trend in the direction of the breakout.
It is important to set a Stop-Loss order to minimize potential losses in case the breakout fails. The Stop-Loss should be placed just below the latest swing low or the ascending trendline.
Maintain a consistent risk per trade by adjusting your position size: This typically means at most 1-2 % of your trading capital. Regarding the risk-reward ratio, it is recommended to set it at a minimum of 1:2. This ensures that the potential reward for the trade is twice the amount of risk being taken.
Consider taking partial profits at the price target and use a trailing stop for the remaining position to capture any extended uptrend. Wait until the pattern develops fully before taking any action, and it is important not to anticipate the breakout prematurely.
What technical instruments will help?
Advanced breakout trading strategies involve more than just identifying support and resistance levels. They often incorporate additional indicators and techniques to improve the accuracy and profitability of the strategy. Here are some advanced breakout trading strategies:
ATR channel breakout strategy. This trading strategy utilizes volatility as a breakout filter. The first step is to add an Average True Range (ATR) filter to the 350-day Moving Average. Then, a long position is entered when the closing price breaks above the upper channel. On the other hand, the position is sold when the closing price ends below a band that is three ATRs subtracted from the Moving Average.
Bollinger channel breakout strategy. This strategy uses Bollinger Bands to spot breakout opportunities. A price breakout above the upper Bollinger Band or below the lower Bollinger Band, accompanied by increased volume, indicates a strong breakout.
Volume breakouts. Volume is an important factor to consider when engaging in breakout trading. If the price breaks through a significant level of support or resistance with high trading volume, it indicates a strong breakout. The high volume confirms that the breakout is valid, and it suggests that there is a significant change in market sentiment.