BreakOut Trading Strategy
A breakout is a stock price moving outside a defined support or resistance level with increased volume. A breakout trader enters a long position after the stock price breaks above resistance or enters a short position after the stock breaks below support. Once the stock trades beyond the price barrier, volatility tends to increase and prices usually trend in the breakout's direction. The reason breakouts are such an important trading strategy is because these setups are the starting point for future volatility increases, large price swings and, in many circumstances, major price trends.
How to identify breakout stocks in trading?
Entry Rules using breakout trading strategy: Generally for a short term trader breakout period of 20 days is used, for a positional trader breakout period of 50 days is used and for long term momentum investor breakout of 200 days is used to enter the trade. Jesse Livermore’s style of trading was of breakouts, he used to describe breakouts as “line of least resistance” that is, when prices move beyond breakout, there is no resistance and thereafter the price glides smoothly in that direction.
For Exits: Generally exit rules are defined on multiple basis, some use moving average crossovers, others use predefined profit targets depending on the initial risk undertaken and rewards expected, still others follow breakout on the opposite side by half the original breakout period. For example those who use 200 days as breakout entry signal, will use 100 days breakout on the opposite side to book profit. But this requires proper back testing and optimization on the number of days to be used for reversing the trade.