Keys to Winning Breakout Trading
12/14/2011 3:00 pm EST
A lot of traders these days are looking for breakout trades, but what does that mean? Our guest is here to talk about that, Bob Seifert. Bob, first of all, what is a breakout trade?
Well, you know the market goes through different phases, and I’m a great believer that it has three phases: congestion, breakout to the trend, and then it ends in a blow off, and the market will then repeat itself.
The key to the breakout trade is when the market is in congestion—in other words, when it’s choppy, when it’s back and forth—it’s going to make a series of highs and lows. The series of highs and lows can expand or they can have that imaginary boundary at resistance and support, and it’s magical. I mean, when it’s really in congestion, it just hits it perfectly.
Eventually, the strong hands are going to take over, and if we’re going to the upside, it’s the buyers. The buyers are going to be willing to pay more and they’re going to force the sellers out.
That leaves a distinct pattern on your chart, and when we buy that breakout pattern, we call that the trend. It’s going to break out to the trend.
There are a lot of theories as to how long the breakout will last, how long the trend will last. Personally, I don’t know.
I do know that when it’s going up—and it’s not going straight up, but I use an angle—as long as the market is advancing at less than a 45-degree angle, price and time are allowing for more buyers and sellers to fill in, and so what I recommend to clients is the breakout trade will offer them a number of opportunities because they will buy the breakout trade, and then when it retraces, they will take profits. They’re not going to let it come all the way back down.
They will then look for the breakout to occur again. Now, I use software that helps me with this, but as long as the major trend is not broken, I will take profit, get to the sidelines, and then buy the price as it goes up.
A lot of people have trouble with this. They will enter the trend, and then they will take profit, and they won’t want to enter again, but as long as that solid support keeps moving up with them, I don’t care if they use moving averages, any kind of technical data that tells them where that price is going, as long as they are willing to take their profit and not be greedy and then are willing to go back with the trend again, they may trade that for six or seven months.
When we had the big rally in the stock markets earlier in 2011, a lot of people referred to it as a “tortoise market,” and it was. For traders, it wasn’t good: low volatility and the price went up every day. No fear, it just kept going up. However, people who kept buying into that all the way up had very, very good results.
So, that’s a basic trade that I teach people, and it is a “bread and butter” trade.
Let’s talk about breaking out from that consolidation for a moment. If you’ve got the top resistance line across all the highs and the support against all the lows, do you like it to close above that resistance line, and what is the confirmation that a breakout is indeed happening?
Well that is very difficult because we do get false breakouts.
Let’s say we’re going to the upside. Once it closes above resistance, I will take my first trade. I will buy the breakout.
Now, if it’s a false breakout, I’ll take my stop. As long as I take my stop, even if it’s a false breakout, I’m not going to get hurt. I may recognize the false breakout and now trade it as a congested trade off the double top.
If it comes back and then it breaks out again, I’m going to buy it. I’m going to hit that trade because it’s eventually going to break out. The other traders will see it. We all have the same information. There is no such thing as unique information.
So, as they see it, the buyers will come in and then the trend will start, though it could be a number of reasons— fundamental reasons why it’s going to go higher, technical reasons, it doesn’t matter. I don’t really look at that.
I just look at the pattern because I know I’ve seen that pattern repeat thousands of times and I use that pattern.