Buying breakouts, along with attempts to pick tops and bottoms tend to be some of the most common methods that people new to the markets attempt to do. The problem is neither of these methods really are suited for the new trader. Before I go on I would like to discuss the reward to risk ratios for breakouts compared to attempting to pick tops and bottoms. The problem with attempting to buying breakouts is that your are suspect to being caught in a market head fake. One problem new traders tend to develop is that they do not have the ability to reenter a trade so instead they tend to violate their mental stops. This is about the worst possible thing you can do. At the same time new traders that stick to their stops often do not get back into trades once they are stopped out and they end up missing the eventual move however they were in a head fake. In a nutshell buying breakouts tends to have a low winning % and the profit potential cannot always be quantified because there are no resistance levels because the trade is making new highs. In attempts to pick tops and bottoms it tends to be very similar in respect to buying breakouts. Although the strategy is nearly the opposite the way people, in particular new traders execute it is mostly the same. When you are attempting to catch the low trying to minimize risk what new traders often do is they violate their stops. This is an even bigger risk when attempting to catch a top or bottom BECAUSE OF the people trading the OPPOSITE strategy of attempting to catch breakouts. Once you violate your stop an the trade begins to break either to the upside or the downside your small loss can very quickly turn into a big loss when this trade turns into a breakout to the opposite side the trade that you were trying to take. Now what is important to take out of all this is to remember what to expect when trading these strategies. When you are attempting to trade breakouts realize that another major party is attempting to fade you and trying to trade tops and bottoms. Also when you are trying to trade tops and bottoms there are people trying to trade breakouts at these points. Because of these very prevalent strategies in the market these points become the key swing or support/resistance points. I believe one of the biggest ways to gain an edge in the markets is to be able to identify these points and trade off the reaction of the market to these points. Instead of trying to have a tendency to buy breakouts or catch tops and bottoms see what the market is trying to tell you and trade off that. In effect trade both strategies. In terms of quantifying reward to risk ratios along with probabilities of a winning trade the trades are very different. People attempting to catch breakouts are going to be wrong a high % of the time but when they win they will win a lot. At the same time people trying to trade tops and bottoms will tend to be right a higher % of the time but their winners will not be as big and their losers will big bigger. The single biggest thing that i have gained during understanding this process is that one must be able to quantify their reward to risk ratio. Before a trade is taken a trader should have their profit potential and risk quantified as a ratio. This skill will not be easy for a new trader to acquire but over time they should begin to get a feel for a close ratio. Using this method along with understanding the key swing points i believe are the single biggest ways for a losing trader to turn around no matter their stategy. What are other peoples thoughts on using these methods to go along with a traders strategy. Personally I have no strategy in particular I just use the method I have described.
There is one way and one way only to make a stock go up and that is to buy it. People buy breakouts because they believe other people will keep buying agressively after them. Actually, it's why people initaiates longs in the the first place, because they think others will come in and bid up the price of the stock. The technique(trend/contrarian) is varied, but the thought process is the same. Breakouts (or any other TA indicator) are precise, but not consistently accurate. Of course, fundamental analysis is neither precise or accurate.
Trying to pick a top/bottom and breakouts is a flawed strat. What are you doing besides trading one against the other? Picking tops/bottoms is in reality just guessing.......are are assuming the mkt has topped out or bottomed out. Breakout trading is where the action is, your goal should be to catch the next intraday swing either up or down. (daytrading index futures, that is. Stock traders cut these chances in half because MOST are BUYERS only). Trading breakouts as explained has its flaws like any other strat. Filters, etc are part and parcel for any strat in a game of probability. What filters to use and or not is subject to the individual. many new traders fail to let that sink in. They see where someone said this and that about this or that and fail to realize the real gist of trading in the real world.............that being the finesse of the individual. many fail to grasp that for a very simple reason, that reason being that they have yet to be baptized under fire.
usually,a stock will breakout and quickly retrench back to former resistance or a bit below before attempting to break out again..thats when i buy,the second time..this avoids the headfake. for example,stock xyz ha strong resistance at 50,the 52 week high is 50.01..the stock is at 49.99 on good volume..the stock breaks 50.01 and buyer's step in,bringing it to 50.05 and then it falls to 49.89..i would wait and buy another break of 50.01 or i would see the low(the tail of the candle)on the pullback from the first attempt and put in a stop just below that...
Thanks Bigbrent, Appreciate your observations on breakout/breakdown trades. It would be helpful if this discussion were to continue: 1. How to identify/scan or find stocks prior to breakout and have them on a watch list of potential candidates. 2. What conditions the trader would want to look for prior to entering. 3. And finally the trade management once entered. I find the hardest part of trading breakouts is to find enough stocks (based on the daily charts) to put on the watch list as potential breakouts. Most of the time, with only a handful of candidates, the trader ends up spending all day or several days waiting for one of these to breakout and confirm. I've not found a good scanning method for my own use and only several websites to get more than a handful of candidates at any one time. Thanks