How to Plan Your Breakout Trading Strategy

Submitted by Stock Market News on 19 May, 2011 - 17:13

Create an objective breakout trading strategy.

Breakouts are useful strategies in a volatile market. Traders can make great returns with limited risk, that is if the trading strategy is executed properly. More importantly, you can apply it any style of trading - including intraday and swing trading – regardless of the time frame. However, breakout trading can take a lot of patience which may cause you to jump in to early and end up exiting at a loss. So how do you plan for an objective trade?

Finding the Right Stock

Consider the stock's underlying resistance and support levels. The more times that a stock has dipped into these levels the more valid the levels become. The longer they play out in a trade the better the breakout will be. Apart from resistance and support levels, you can also look into price patterns such as channels, triangles and flags.

Breakout Entry Strategy

When the price is close to the resistance level establish a bullish position. On the other hand if it is below the support level, establish a bearish position. To be able to determine whether its a breakout or a fake out wait for a confirmation such as an above average volume. Fake outs happen when a price steps beyond a support and resistance level but moves back to its previous trading range at the end of the day. If jump in without a confirmation you have no guarantee that the price will remain in its new direction.

Exit Strategy

Use the most recent price action to determine your price target. For example if the recent range of a channel or price is 5 points, then use that amount as a price target when the stock breaks out. You can also use the average of current price swings. The price target will be your objective. Once it is reached you can then exit your position, or you can exit a portion of it and let rest run with a stop loss order.

  • Exit with a loss

    Unfortunately, breakouts can fail. The stock retests a previous resistance or support level, then breaks through it instead of forming a new resistance or support level. If this happens exit and move on, then use this information to set your stop loss.

Stop loss

Take a look back and identify where the breakout failed. To minimise risk, place your stop loss below a previous support or resistance level where the price had broken. This way you will be able to protect your position with minimal downside risk.

This points are useful when your developing an objective trading strategy. You can test your method through simulation or paper trade if your still not confident enough to take the risk.

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