4 Key Factors to Watch Out in Trading Breakouts
1. Knowing the Key Levels of Supports and Resistances
In trading breakouts, it is important to determine the key levels of supports and resistances to watch out because it will be the primary basis for your trading decisions. For instance, when trading long positions, you might want to focus on screening stocks that are close to their resistances.
It’s popular amongst all traders to use structure resistances and trendlines as a basis for determining a potential breakout play. Structure resistances are the fixed resistances on the chart. It occurs on a recent swing high, usually a wick. On the other hand, trendlines are used when prices are forming a lower low or a higher high. In trading short positions, the same concept applies but your focus will be on the support levels of the stock.
2. Watching Out for Chart Patterns
Trading breakouts have a higher chance of success when you see a bullish or bearish chart pattern, depending on which side you plan to trade. For instance, when you see an ascending triangle chart pattern, you will expect a breakout on the highs of the pattern.
The textbook definition of the ascending triangle pattern is said to be bullish because the price is being contracted in an upwards direction. The pressure of the bulls on the stock will most likely break the one-line resistance of the pattern. Therefore, if you see this pattern, enter a long position at a few ticks above the resistance.
In trading, there are a lot of chart patterns to keep in mind. You should study the psychology of each pattern to understand its move then combine it with the concept of support and resistance and you’ll have a higher chance of success at trading breakouts.
3. Confirm a Breakout by Looking at Its Closing Candle
When trading a breakout, there are two important factors to consider in confirming if a breakout is successful or a fake one. The first thing to keep in mind that the breakout should have a good closing candle. The second confirmation is that it should have a larger volume to confirm the presence of traders who traded.
In a candle’s closing price, the price must close above the resistance. Otherwise, this is called a fakeout. In a long position, a successful breakout always closes above its resistance because it means that the bulls have defended the price level of which the stock broke out. In a short position, the same concept applies but alternated.
There are some traders who confirm a breakout by looking at the closing of the whole range of the candle. Usually, traders are convinced if the price closed above 50% of the whole range of the candle. This means that if the move of the breakout candle has a range of $2 to $3, then the candle must close above $2.5. Moreover, traders are very optimistic if the closing price is above 75%.
4. Make Sure Your Stock Has Enough Participants
Looking at the volume is also an essential thing to do. This is because if the breakout doesn’t have enough participants, chances are it will go back below its range because there aren’t enough bulls to defend the price from the bears. One way of checking this is by looking at the average volume. By default, the moving average of the volume is 20. When looking to buy at a breakout, you should observe if the stock traded above its average volume. If that’s the case then you can buy it.