Trading Education Trading Help Learn to Trade
- By Lucien Bechard
- Updated February 13, 2024
5 min read
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What is a stock breakout? It is a technical analysis term defining a price movement that passes a resistance level. Usually, this is a bullish reference, as a breakout is considered where the price is moving up through the resistance zone, and a breakdown is a reference to the price doing the opposite (moving down). This can happen on any time frame and is always best when confirmed with volume. The movement continues until the next resistance level. A breakout will typically be accompanied by increased volume, which indicates that the buying/selling demand is more than the supply, and the price follows. Breakouts are the beginning of trends in a security’s price. We will explain why breakouts happen, their types identifying them, and how best to trade them.
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Table of Contents
- What Causes a Stock Breakout?
- How It Might Happen
- Identifying a Stock Breakout
- How Do You Buy on Breakouts?
- Final Thoughts
What Causes a Stock Breakout?
For our discussion, we will deal only with bullish breakouts. However, there are equal and opposite shorting opportunities with downward breakouts after consolidation. Uptrends will begin with a stock breakout, passing a support level with strong volume, leading to higher highs and higher lows on the backs of FOMO buyers and short-sellers covering their bad decisions. The key is the heavy volume as a buying spike spurs new highs. The result is a prior resistance level now becoming a new support level.
How It Might Happen
A smart money trader may short a stock at aresistance level and buy at the support level, staying in a range. The more the range repeats, the more she repeats her moves, but other traders will follow her play. It becomes apparent that some short-sellers continue their sales slightly above the resistance level as the price passes it, assuming another pullback doesn’t come.
As the price increases, to resolute builds with o, you’re a smart money investor covering her position to prevent severe losses. At this point, both retail and institutional fence-sitters jump in, trying to catch the upward surge. The price and momentum bring in volume, with the last short-sellers covering their positions. The stock is now hitting intraday scanners, and even CNBChas begun discussing the new breakout.
This pushes FOMO buying to continue the upward climb. And you have a stock breakout. It can happen quickly, and you don’t want to be chasing those trades.
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Identifying a Stock Breakout
Usually, a stock breakout will be anIntraday breakout whenscanners and Fox Biz/CNBC/Bloomberg promote a day’s fast-rising stock. Or a52-week breakoutwhere a company makes a new high and is also discussed onfinancial news. This, however, may mean that transparency has been fully recognized, and profit-taking is likely to happen soon.
These two types can be broken into three categories:
- Reversal Breakout– a down-trending price that reverses and spikes with high volume. Bargain shoppers and buying and shorts cover their positions. This stock breakout is often a result of positive news.
- Consolidation Breakout– A trading range with identifiable and definedsupport and resistance levels and light volume. The breakout forms tentatively with rising volume and then violently spikes with volume.
Triangle Breakout– The resistance level is flat with a rising support level (ascending triangle). Motivated buyers are increasing their bid price, reducing the pullback range, which shrinks to nothing, and the resistance level is broken.
How Do You Buy on Breakouts?
Trading a stock breakout is an eight-step process:
- Identify Candidate- The asset must have strong support and resistance levels; the more robust, the better.
- Wait for Breakout- Don’t jump the gun; look for movement and confirmation(differs from wiggle or head-fake when breakout sustains price above the prior resistance level) outside the resistance level; usually, end-of-daytradingis best.
- Set Profit Objective- Set a profit level the same size as the previous support and resistance range’s height, and don’t be greedy.
- Allow for a Re-test- With a breakout, the prior resistance level becomes the new support level; it will likely test that again, so don’t be surprised.
- Look and Plan For Failure-If your stock re-tests the new support level and drops back to the old range, it has failed.Set a stop lossto close your position, usually around 80% of the previous range height.
- Exit A Questionable Trade Near The Market Close-Much can happen overnight, and the opening can differ. If you are below the support level, it is better to close the trade just before the market closes; move on and find a new opportunity.
- Patience Is a Virtue– remove emotion from your trading and be objective.
- Exit Trade at Your Target-remain in the trade until you reach your goal and get out. You may also set a time target to exit t the current price.
Final Thoughts
A stock breakout is an easy-to-identify trade that can lead to consistent gains. Make sure to monitor them closely and act when necessary. The more experience you get finding and playing them, the better you will become. Like always, never put at risk in one trade more than you can afford to lose, and good luck with all your trades.
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