How to Profit on Momentum Breakouts
06/11/2014 7:00 am EST
Focusing on trading specific day and swing trading entries can be made much easier by entering your trades primarily during two-day high breakouts. These occur when the chart is breaking to new highs above the prior day's high and represent one of the most powerful day and swing trading signals an active trader can use to avoid false breakouts and capitalize on strong continuation trades.
The reason for this is because two-day high/low breakouts occur when institutional traders use "high-frequency" trading programs to issue high-volume buy orders. Retail traders can capture strong breakouts by entering these momentum plays as well, once they understand how to enter their trades correctly.
How to Enter Day and Swing Trades
Whether you're a daytrader or swing trade equities, the signal set-up to use is relatively easy to understand. Looking to enter your trade during days in which whatever equity you're trading is clearly above the prior day's high is the main signal to start using.
For example, in Figure 1, Red Hat (RHT), you can see the breakout above the prior day's high over $47, in which it's already moved up a full point, to $48, by 10:30 am EST. Note too that the volume during this day's price action is clearly higher than the prior day's volume, which is a confirmation signal.
To enter a day (or swing) trade, the strongest trade signal is to simply wait until price has moved 35 cents or so above the prior day's high before entering the trade. This helps avoid "false breakouts" that often occur exactly at the prior day's high, while getting into a successful, winning trade set-up that continues.
For swing traders, you can enter a buy-stop order using your brokerage account before the market opens to activate the trade entry. In this RHT example, the buy stop order would have you in at $47.35 ($47 + $0.35) for a winning entry.
Next, let's look at Figure 2, Adobe (ADBE), in which the prior day's high occurred near $27 per share. The entry trigger for today's trade would be to therefore buy at $0.35 above today's opening price, which would be ($27.80 + $0.35) $28.15. It has since moved to $28.80 and is still trending up.
Strongest Entries: Combining Two-Day and 15-Day-High Breakouts
The very strongest signals occur when your stock has just broken to new highs above both the two-day and 15-day high breakout signal lines.
In Figure 3, United Airlines (UAL), two day, you can see a clear two-day-high breakout continuation pattern as it takes out highs over $21 per share. Combined with the pattern in Figure 4 (UAL, 15 day), in which it's also taking out new 15-day high price action, this is a very powerful breakout continuation pattern that's worth scanning for as you spot new trading entries.
It's also worth noting that you can use 15-day high continuation patterns to add to existing trades to "scale in" by adding to winning entries for additional leverage. The best winning day and swing trading entries consistently come from scaling into breakout continuation trades in an uptrend to leverage trading capital successfully during momentum breakouts.
Positions are added every whole number up; for example, an initial trade could be entered at $21.50, a second entry at $22.50, and so on, using a $0.75 to $1 trailing stop to lock in potential profits.
How to Avoid False Breakouts
Whether day or swing trading stocks, the biggest single challenge is getting into a trade that promptly goes against you. It's frustrating, and it will always be part of your trading life.
The way to manage it successfully is to 1) use "false breakout price filters" designed to keep you out of choppy charts, and 2) keep relatively tight stops and scale into winning trades using careful trade management techniques.
I've found that buying a cup breakout that occurs at new two-day highs is the single best overall strategy. As mentioned earlier, it's best to wait until it's at least 35 cents above the prior day's high before entering.
Another price-based filter is to make sure that you are not buying if you missed an initial breakout and it's already traded to the edge of its Average Trading Range (ATR), as determined by the prior day's high-low range.
In Figure 3 (UAL, 2-day), for example, the prior day's range is ($20.80 -$19.80) $1, so one would not trade this if it moves up a full dollar in today's breakout near the edge of the breakout range since the price is extended and likely to retrace.
By harnessing the power of these simple (yet effective) equities breakout strategies, you can potentially make more successful trades as well.
By Ken Calhoun, founder, DaytradingUniversity.com.
Ken Calhoun is a trading professional who has traded millions of dollars in equities since the 1990s. He is the producer of multiple award-winning trading courses and video-based training systems for active traders. He is a UCLA alumnus and is the founder of DaytradingUniversity.com, a popular online educational site for active traders.