Trading Breakouts
Breakout trading relates to certain continuation strategies where costs are assumed to continue increasing (in an up trend) or decreasing (in a downtrend). While it’s quite possible to make a good income from trading within a range while the prices are varying between support and resistance levels, particularly if you are using spread betting or another derivative to provide leverage of your money, when you trade breakouts the amount that the price can change is not limited in the same way. A breakout is by definition a pushing of the price beyond a previously limiting price level.
In this case you are looking for stocks or securities that have been constrained to a limited range of prices for a time. The support and resistance levels are then well defined, having provided barriers that have not been broken, at least within recent price history. You may see signs in technical indicators that there is pressure building up within the range, or you may just keep a close watch on the price when it comes near to one extreme of the range.
Either way, you are looking for the price to go where it has not been before i.e. traders wait for new highs or lows to be established. If you are spread betting, or using contracts for difference, you are able to take a position and leverage your funds to multiply the potential profit. As soon as the price crosses the boundary, and closes a session on the other side, you can consider placing the trade.
When looking for breakouts traders look at existing trends but also look at support and resistance levels; in particular price points that may reveal that the trend is intact or starting to end. For instance, spread betters might latch into an uptrend only should it break thru a preset resistance level, or go short in a downtrend only once a certain support level has been punctured. The target here is to maximise gains as stock prices could move sharply once they break through certain trigger points.
Some technical analysts make this a less risky trade by insisting on the price closing on the other side for two successive days; or by setting a certain amount or percentage by which the price should break through the price barrier. This is a matter of trading style. However you want to confirm that the old pattern has been broken, once the price has satisfied those criteria you would place the trade and wait to see what unfolds.
The stop loss would initially be placed at the boundary level, in case the breakout failed and the price came back into range. After that, a trailing stop would be a suitable order to capture and keep the profits. Once the price movement was fully established, the resistance (or support) that was broken through would form a barrier from the other direction, and you would expect it to be a support if previously a resistance.
Another way of taking advantage of these kind of trading opportunities is to look for breakouts below a low or above a high. In fact, a popular trading strategy involves looking for shares making new 52-week highs (to buy) or shares making 52-week lows (to short).
With a breakout move, your stop loss position is clear, and so it is easy to work out the risk level. The target price is not so well defined, but sometimes the price will move about as far above the resistance as the size of the trading range it has left. The reward to risk ratio is usually very good, because the stop can be placed so tightly against a failure of the move.
The problem with such an approach is that it requires traders to ‘buy high and sell low’ which means that traders utilising such tactics rarely get the best entries. However, many traders still like to utilise breakout spread betting strategies since this makes it possible to have clear entry price levels – which normally are linked to increased volatility (possibility of bigger winnings).
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