Breakout Trading: Overview, Types, and Example

In the market of financial securities, there are vast numbers of opportunities for traders in predicting breakouts at the correct time and can offer great returns. Breakout trades are quite difficult to predict which requires trading experience with accuracy. To learn how to do breakout trading and how to predict breakouts in the security for profitable returns, delve deep into this blog.

What is Breakout Trading?

Breakout trading is a specific trading strategy which aims to buy or sell the financial securities when they break defined price levels in the charts. A breakout trader adopts this strategy by researching potential securities that broke through significant support or resistance levels with a surge in volume.

Breakout traders mostly track the consolidation period where the prices of a security roam around a tight range, suggesting a balanced stage of buyers and sellers. Typically, a trader waits for the prices to break this range with increased volume and go with the trend.

Types of Breakout Patterns

Breakout traders identify the patterns or areas from where the prices break a significant level while providing profitable trading opportunities in the financial market. Some commonly traded breakout patterns include:

Horizontal Breakouts

A horizontal breakout level occurs when the price forms a horizontal pattern like a rectangle as it ranges between the same levels for a certain period of time. Traders identify the stock trading in a narrow range since a long time and hence pick profitable opportunities at the breakout levels.

Trend Line Breakouts

Suppose a stock trades in uptrend making higher highs and higher lows within the trend line, when the price breaks the trend line indicating a potential downwards reversal, breakout traders make their position downwards to make certain profits.

Triangle Breakouts

You must be quite aware about triangle patterns which are classified as ascending, descending, or symmetrical triangle patterns. In a triangle pattern, a breakout occurs when the price breaks the support or the resistance level.

Head and Shoulders Pattern

Head and Shoulders pattern is recognized by the three peaks, middle one being the highest representing the head of the pattern while the side ones being the shoulder of the pattern. The pattern gives a profitable breakout when prices tend to break through the neckline of the pattern with a surge in the volume.

Flag and Pennants Breakout

Breakout trades are initiated when the price breaks out of the flag or the pennant pattern which is marked by an extended period of consolidation that is followed by a breakout in the continued trend.

How to Identify Breakouts?

To find breakouts in financial assets, an individual requires a great trading experience as it comes with analyzing securities on a regular basis. However, potential technical indicators help you to analyze the market and the assets guiding you about the breakout direction.

• Watch out for the stocks that are following a critical level and are about to give the closing, breaking those levels either downwards or upwards.
• Place you stop loss at the levels in the opposite level of the range to manage the risks and avoid further losses.
• Use technical indicators and chart patterns to support your trading strategy such as Moving Averages, Relative Strength Index and MACD and measure the strength of breakout.
• Volume is an important factor to rely on breakout trades as increase in volume gives the required movement in the prices.
• To give a good breakout, a longer consolidation period is preferred.

Breakout Trading with Demand and Supply Approach

Breakout trading can help traders to gain quick profits, however certain limitations are always associated with trading for which demand and supply theory proves to be more reliable compared to other technical indicators.

To trade breakout patterns, look for the demand zones at higher time frames from which the prices have moved upwards with sufficient consolidation period. If the price continues to follow the formation of new demand zones, it signifies a great buying pressure in the security. A breakout in the security is confirmed after the consolidation period with a sudden surge in the volume when the prices are pushed by demand zones. This consolidation period mainly aims to finish the selling pressure of the security as the price tests the above levels each time.

At the end, the formation of doji candles determine the fight among buyers and sellers which signal the potential breakout in the security and hence diminishing the sellers.

The formation of continuous or reversal chart patterns for breakout trading is an additional advantage in demand and supply approach. And hence, the efficiency and reliability of the breakout increases potentially. To learn these advanced concepts in detail, you can watch the full Trading in the Zone course on YouTube for free.

Advantages of Breakout Trading

Analyzing breakouts at support and resistance levels allows traders to make quick profits without blocking their funds for a longer time frame. 

Breakout patterns in the stocks can be observed across different time frames, therefore; it allows positional traders, intraday traders as well as swing traders and investors to pick profitable opportunities.

Breakout patterns determine sudden reaction in the security, if the reaction gets delayed due to any factor, traders get exit signals which offer time efficiency.

Limitations of Breakout Trading

Breakout trading is one interesting form of trader and a trader can earn quick profits through breakout trades. However, this is not always the case, there are some important considerations which an investor must be aware of to protect the profits and generate profitable returns consistently. Let us know what can limit the breakout trades:

False Breakouts

False breakouts are very common in the financial market because of increased manipulation which is a big disadvantage to breakout trading. A security forms the breakout pattern followed by a consolidation period but ends up retracing back into the previous trading range which leads traders to bear potential losses.

Market Volatility

Market is always uncertain, sudden movements in financial markets can never be ignored which makes breakout trading to be highly challenging. A sudden price movement may trigger the stop losses and result in losses for breakout traders.

Entry and Exit Points

It is quite difficult to analyze the potential level of the breakout as it is quick and volatile, traders cannot capture the whole move as there are no defined entry or exit points. In some cases that might lead to certain losses.

The Bottom Line

Breakout trading strategy in technical analysis is one interesting strategy that has the potential to offer maximum returns within a limited time period. On the other hand, looking at the limitations of breakout trading strategies, traders must be very cautious with their risk management. Demand and Supply theory guides them the best to achieve accuracy and reliability which can be learned from Trading in the zone course offered by GTF which is an advanced technical analysis course.

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