How to Identify Confirmation of a Trade Set-up

11/30/2015 6:00 am EST

Focus: STRATEGIES

Watch for these key signals, which can validate your analysis and provide added confidence when executing trades.

Confirmation is necessary to validate a break of important support and resistance levels such as price patterns, moving averages, and trend lines. Technicians and traders define confirmation in various ways. While market situations vary, below is a guideline of three forms of confirmation:

  1. Percentage Confirmation: Confirmation is present when there is a 3% or greater break of a support or resistance level. Volume attached to the break, while not necessary, lends confidence to the confirmation. The 3% rule is commonly used by long-term traders and investors. Short-term traders use a lesser requirement to complement trading objectives, keeping risk/reward in line.
  2. Time Confirmation: If there are at least two closes above or below a resistance or support level, then confirmation exists. A close varies based on one's trading time frame. Again, volume attached to the break adds significance to the confirmation.
  3. Heavy Volume Confirmation: Volume confirmation is present when there is a substantial surge in volume relative to recent volume, combined with one close above or below a resistance or support level.

Combination: If percentage and time confirmations fall short of the minimum requirement, but are accompanied by substantial volume (e.g. 1.5% close above resistance with substantial volume), this could be accepted as confirmation.

Investors and traders can use this guideline to develop their own requirements for confirmation, as individual investment objectives and time frames vary.

Illustrated below are historical examples of confirmation applied to various trade ideas from five years prior:

Time Confirmation for Bullish Breakout in JPM

The chart below shows a breakout triggered in JPMorgan Chase (JPM) when the price broke through resistance at $41.75 on December 22, 2010. Time confirmation occurred a day later with two daily closes above resistance.

chart
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Bullish Breakout for OGE

Finally, we observe that a breakout of a bullish ascending triangle occurred in OGE Energy (OGE) on January 3, 2011. No confirmation was present and the trade failed.

chart
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By Zev Spiro

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