Technical Analysis by Darren Winters
Talking about breakouts makes me think of my favourite Foo Fighters album track where David Grohl is singing about wanting to ‘breakout’ of the relationship he is in. I guess it’s not dissimilar to a stock that is trying to breakout of a trading range it’s been in or above a key resistance level!
Breakouts can form the beginning of an exciting new rally for a stock or alternatively, the start of a large downward leg. There are simply too many types of breakouts to go through each one individually, but if we give some examples, you should be able to get a feel for how they develop out of a multitude of chart patterns. We will also cover the ‘false breakout’ that can often leave inexperienced traders scratching their heads.
CONSOLIDATION BREAKOUTS
Consolidation patterns come in many forms, but some of the strongest patterns that develop out of a consolidation are perhaps ‘flags’ or ‘pennants’. We have covered these patterns in previous editions of the newsletter so wont go into long winded explanations at this point.
Essentially, consolidations occur when a stock has been trending in one direction or another. For example, if a stock has been rallying, it will get to an area of resistance where sellers enter the market and halt its advance. At this point, the stock starts to move in a sideways direction where the number of sellers matches the buying pressure. Once all the selling has taken place and if there are still buyers, the stock can then start to rally again.
It is at the point when a stock ‘breaks out’ of this consolidation pattern that traders can take advantage of the next rally leg.
The chart above shows a classic example of a stock forming a flag before breaking out to the upside. Of course we can see the opposite of this bullish formation in down-trending markets. It is worth noting that you want to see an increase in volume on the breakout to help confirm the move. If volume starts to fall, you may want to tighten stops or even close part of your position. Sometimes a stock may come back down and ‘retest’ the area that it broke out from so it is worth bearing this in mind.
The best way of trading breakouts is to get plenty of practice first. Using your charting software, flick through as many charts as you can, searching for these consolidation patterns. You can then look to see how each stock reacted to the breakout and what happened to the volume. These breakouts work best in strongly trending markets.
FALSE BREAKOUTS
Although we see breakouts occurring all of the time, so too are false breakouts. When you consider the number of traders who are well aware of consolidation patterns and waiting for a breakout, you also have to be aware that market makers can have fun with these.
Let’s assume a market maker has some very large institutional sell orders coming in on a stock that is just sitting below a key resistance level. It would be very easy for that market maker to start pushing the price up above the key area to entice buyers into the market. This surge of buying can then enable them to fill their large sell orders for the institution and thus the price comes crashing back down.
Watch for a breakout on light volume, or a shooting star candle as this can tell you all is not well.
Both genuine and false breakouts can be taken advantage of. Watch volume to give you confirmation of any moves and watch for non confirming indicators should a breakout turn out to be false.
Darren Winters
Breakouts can form the beginning of an exciting new rally for a stock or alternatively, the start of a large downward leg. There are simply too many types of breakouts to go through each one individually, but if we give some examples, you should be able to get a feel for how they develop out of a multitude of chart patterns. We will also cover the ‘false breakout’ that can often leave inexperienced traders scratching their heads.
CONSOLIDATION BREAKOUTS
Consolidation patterns come in many forms, but some of the strongest patterns that develop out of a consolidation are perhaps ‘flags’ or ‘pennants’. We have covered these patterns in previous editions of the newsletter so wont go into long winded explanations at this point.
Essentially, consolidations occur when a stock has been trending in one direction or another. For example, if a stock has been rallying, it will get to an area of resistance where sellers enter the market and halt its advance. At this point, the stock starts to move in a sideways direction where the number of sellers matches the buying pressure. Once all the selling has taken place and if there are still buyers, the stock can then start to rally again.
It is at the point when a stock ‘breaks out’ of this consolidation pattern that traders can take advantage of the next rally leg.
The chart above shows a classic example of a stock forming a flag before breaking out to the upside. Of course we can see the opposite of this bullish formation in down-trending markets. It is worth noting that you want to see an increase in volume on the breakout to help confirm the move. If volume starts to fall, you may want to tighten stops or even close part of your position. Sometimes a stock may come back down and ‘retest’ the area that it broke out from so it is worth bearing this in mind.
The best way of trading breakouts is to get plenty of practice first. Using your charting software, flick through as many charts as you can, searching for these consolidation patterns. You can then look to see how each stock reacted to the breakout and what happened to the volume. These breakouts work best in strongly trending markets.
FALSE BREAKOUTS
Although we see breakouts occurring all of the time, so too are false breakouts. When you consider the number of traders who are well aware of consolidation patterns and waiting for a breakout, you also have to be aware that market makers can have fun with these.
Let’s assume a market maker has some very large institutional sell orders coming in on a stock that is just sitting below a key resistance level. It would be very easy for that market maker to start pushing the price up above the key area to entice buyers into the market. This surge of buying can then enable them to fill their large sell orders for the institution and thus the price comes crashing back down.
Watch for a breakout on light volume, or a shooting star candle as this can tell you all is not well.
Both genuine and false breakouts can be taken advantage of. Watch volume to give you confirmation of any moves and watch for non confirming indicators should a breakout turn out to be false.
Darren Winters
posted by Darren Winters at 11:17 AM
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