How to trade breakouts

Breakout trading is a concept that allows traders to enter a trade at its early stages with a significant trading volume. Breakouts occur when market participants are strong enough to drive the price beyond solid support and resistance levels. Although the concept is simple, there are risks of fakeouts that may result in losses. Discover how to determine the price direction correctly. 

Some websites provide information on stock breakouts. This is when a stock price breaks above or below a moving average. MarketBeat is an example of such a website with the most popular global stocks. 

What is a breakout trade?

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A breakout trade refers to opening a position when a price breaks above a solid resistance level or falls below a strong support level. As increased trading volumes accompany a breakout, a trader opens a position in the direction of a breakout. 

Breakouts may signal a price reversal and a trend continuation. A significant advantage of breakouts is that they can occur and be solid on any timeframe. 

Breakout trading term is used for both market conditions — when the price breaks above a resistance level and falls below a support one. However, sometimes you may see that a fall below a support line is called a breakdown. Still, there is no difference with the breakout concept.

How to trade breakouts and breakdowns

Breakouts are used to enter the market at early stages. Thus, as soon as the price rises above the resistance level, you should buy. When the price falls below the support level, you should sell. 

To trade breakouts like a pro, you don’t need specific knowledge. It’s enough to look at a chart. Breakouts occur after the price trades within a narrow channel and touches either support or resistance level at least two times. As the price trades within a limited range for a considerable period, price volatility increases after the breakout occurs.

Another benefit of breakout trading is that you can easily define an exit point. Usually, the distance the price goes in a breakout direction equals the range within which the price was consolidating. 

You only need to draw support and resistance levels to find a breakout. They can form a channel or be a part of a pattern.

Common breakout patterns

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There are numerous patterns that involve a breakout. The most common examples are head and shoulders and inverted head and shoulders, double/triple top/bottom, wedges, flags, pennants, and triangles. Some of these patterns predict a trend continuation and some form ahead of a trend reversal. Let’s consider how to trade breakouts on the triangle pattern. 

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How to trade triangle breakouts

There are three types of triangle patterns. These are ascending, descending, and symmetrical. 

  1. An ascending triangle is mostly formed in an uptrend and signals a continuation of the price rise. When the price breaks above the resistance level, it signals you can buy an asset. The potential target will equal the distance between early points of support and resistance levels.
  2. A descending triangle is mainly considered a bearish pattern. You can open a short position when the price falls below the support level. The take-profit target will equal the distance between early points of support and resistance levels. 
  3. A symmetrical triangle can provide both bullish and bearish signals depending on the breakout direction. The target will equal the distance between early points of support and resistance levels. 
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How to trade a breakout: breakout and fakeout

It’s a common situation when a breakout turns into a fakeout. 

A fakeout is when the price breaks a support or a resistance level, but market makers aren’t strong enough to drive it further. Therefore, the price turns around. 

What is position trading, and how does it work?

As breakouts occur on increased trading volume, you can use the volume indicator to confirm the market is strong enough to drive the price. 

To close a losing trade, you need to place a stop-loss order near the breakout line. If the price breaks above a resistance line, it will turn to support. Therefore, a price return below this level will confirm a losing trade. If the price falls below the support level, it will become the resistance. Thus, if the price breaks above a new resistance, a losing trade is confirmed.  

Takeaway

Breakout trading is a popular concept that can be applied to any timeframe and financial instrument. It implies clear take-profit and stop-loss levels and allows trading in any market condition. Still, if you want to learn how to trade breakouts like a pro, you should practice a lot.

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