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Breakout Trading: Technical Analysis Primer

Challenges of Breakout Trading

The biggest challenges for would-be breakout traders are psychological -- particularly for investors with fundamental value backgrounds. For upward breakouts, waiting for a stock to move higher before buying can feel incredibly unnatural for an experienced value investor. And staying in the game after a string of losing trades can wear away at the confidence of even the most experienced trader.

It's no surprise then that an estimated 90% of retail traders eventually go bust.

But it's crucial to think like a technician if you're going to find success as a breakout trader. Instead of using technicals as a way of predicting where share prices are headed in the future, you're using technicals to define supply and demand characteristics that lead to a higher probability of a move in one direction than a move in the other.

In other words, breakout traders are looking for "high-probability setups" where share prices have moved outside of the price barriers created by support or resistance levels. To fundamental investors, it's enticing to buy shares before a breakout actually happens - but the breakout is the critical element of creating that high probability setup. Before it happens, the market's bias doesn't give an advantage to the trader.

On the Lookout for Breakout Trades

The first step toward becoming a breakout trader is to be on the lookout for potential breakout trades. Historically, market technicians have done this by poring over thousands of stock charts to find those that looked primed for a break outside of a previous support or resistance level. Today, advanced quantitative screening software can take away much of that work by identifying a watch list of breakout setups in just a few minutes.

Once those setups have been identified, it's time to set conditional alerts for each of the watch list stocks; you'll want to know exactly when the breakout conditions are met. Normally, you can set free trade alerts through your broker's trading platform. By using alerts instead of stop orders, you're able to weed out stocks whose breakouts aren't statistically valid (that is, not confirmed by a material move outside of the support or resistance level) or are just intraday whipsaws.

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