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TheStreet Open House

Breakout Trading: Technical Analysis Primer

BALTIMORE ( Stockpickr) -- If you're familiar with technical analysis, chances are you've at least heard the term "breakout trading" before. The foundation of the uber-successful trading systems used by some of the biggest Wall Street investment managers, breakout trading is one of the most effective technical strategies out there -- and also one of the most nerve-wracking.

In this week's technical primer, we're going to take a look at exactly how a breakout trading strategy works, and how to implement it for your portfolio.

It's one thing to analyze technical charts ex post to find trading opportunities -- and yet another to pull the trigger on a real trade. Using a technical strategy has significant advantages. Whether used as a standalone method of analysis or as a timing supplement to fundamentals, technicals can provide significant cues about a stock's potential price movement.

Related: 3 Stocks With Bullish Technical Setups

Almost any method of analysis seems great in theory, but the money's made where the rubber meets the road. Not surprisingly, applying technical analysis concepts to real-world markets is also where most people (particularly those with fundamental backgrounds) have the most trouble.

What is Breakout Trading?

Breakout trading is one of the most popular methods of applying technical concepts to live financial markets. In its simplest form, breakout trading is the practice of buying stocks as they "break out" above a past resistance level or "break down" below a past support level.

The rationale for this strategy is simple: If support and resistance levels act as barriers to share price movement, then the breach of a previous support or resistance level should leave shares free to make a larger move.

That's a fairly pragmatic approach to trading. After all, if a resistance level represents a glut of supply for shares of a stock at a particular overhead price, then a breakout above that price level should mean that those sellers are adjusting their ask prices to higher levels (or opting not to sell at all), clearing the way for shares to get bid up to higher prices.

As I said earlier, though, there are significant challenges to being a successful breakout trader.

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