Breakouts

The first strategy we will learn is a breakout strategy. A breakout strategy is a very self-explanatory strategy in that it is a strategy in which price "breaks out" of a trading range. This is typically a moment where many buyers or sellers become involved in trading and a breakout is normally accompanied by an explosion of volume and volatility.

Before we get into any charts or buy and sell signals, let's gain an understanding of the players who will be involved in a breakout. Before a breakout occurs, price is typically trading within a range. This means that it has been bouncing back and forth between two points for a period of time. As we will learn later, trader who trade within a range trade the bounces and buy and sell at the moment of least risk, or the moment immediately before price reverses and falls or rises back into the range. Therefore, immediately before the breakout occurs, there will be many traders who are trading the opposite direction of the break, causing increased volatility and volume. Additionally, since traders who are range-trading will be positioned opposite the direction of the breakout, as soon as the breakout occurs, those traders will be losing money. This means that many of them will be forced to sell or cover their position, further adding to the strength of the breakout.

Breakouts

Above is a very simple drawing representing a trading range and price breaking out of the range. In the ideal world, a trader would participate as soon as price closes outside of the range. It is very important that a trader participate as soon as price closes outside of the range. This is because very often, there are "fake outs", or moments where during the middle of a candle price appears to be breaking out of its channel but falls back into the range, causing frustration and losses among breakout traders. By waiting for a close outside of the channel, the trader is verifying that indeed, price did break and a new trend may be beginning.

Below is a chart of a real breakout. The time scale as well as the price change have been removed, because price and its behavior are fractal. Fractal simply means that they follow the same pattern regardless of the time frame.

Resistance Trade

In order to properly trade a breakout, the trader must participate as soon as the trade closes outside of the range. Their initial stop loss order must be at the most recent retracement inside of the trading range. Additionally, they must constantly monitor the trade and be ready to stomach any correction as price adjusts to the (hopefully) newly-formed trend. As the trend develops, the trader must place stops under retracements as they form. There is no clear and definitive guide to a retracement, because seldom do retracements repeat exactly the same. As soon as a retracement clears the highs of itself and resumes trending, the trader is allowed to move his stop loss to a short distance beneath the lows of the immediately prior retracement. It is important that as a trend develops, the trader places the stop a short distance beneath the prior retracements. Many traders and trading groups have learned that if they can push price a few cents or pips beyond obvious support or resistance they are able to capture a few shares or contracts from traders who make the mistake of placing their stops in obvious locations.

Summary - How to trade a breakout:
1. Buy or short as soon as price closes outside of a trading range.
2. Place stops beneath progressive retracements.
3. Exit as soon as a stop is hit or momentum wanes for an exented period of time
4. Draw new support and resistance and wait for a new opportunity to unfold
5. Never trade against the primary trend.