Breakout trading systems

Trading breakouts has one superior advantage, it can be combined with a hard stop loss so that a low risk entry is possible.

  • Trading a breakout needs a base, a triangle or a price channel or range with an edge that can be broken. The more smooth this edge is and possibly the counterpart on the other side of the range, too, the better. Adding to that, the smaller the base or price range itself is, the clearer the signal. Traders are accustomed to identify phases of price contraction and low volatility and intuitively expect a breakout. That is part of why this trading method works.

  • However, there are stronger market participants, who know this and keep on purpose prices in a range so that they can initiate a breakout themselves. This works by holding the market on the other side, driving the price through the range and letting it break the edge. At this point others take over and the market manipulator has entered the market at the best levels. He is possibly able to drive the price even further by supporting the movement during pullbacks. A fine looking signal from a charting perspective may allow him to produce even a small trend. If things go not that well, the predator will be the one with the smallest loss, if any.

  • While many traders only look for some range, it pays off to mind the preceding price action. Search for a trend that pauses in a range. More often than not a breakout in the direction of the former movement occurs and possibly more important it has more likely the potential to resume the trend, resulting in a much bigger gain.

  • This leads to the stealth breakout technique. Enter the market when the price is captured in a range after performing a trend and don't wait for the breakout itself. The cost of slippage should be diminished greatly this way and a more tighter stop loss is possible. In the stock market generally an uptrend should be used for this system, because downtrends are statistically more choppy with stocks.

  • Often price action contracts before a news announcement. In this case two stop orders entered on each projected break line of the base capturing automatically the right side may be interesting. After one side got hit, the other acts as the stop loss order.

  • In the futures markets more than elsewhere reigns the rule, that if the market doesn't break out at one side or the break gets pushed back, prices must or will break out on the other side. Even more generally, if the market doesn't do what seems logical now, it will do the opposite. So beware when applying the former technique.

  • Moreover the futures markets are especially prone to false breakouts. While in earlier decades breakout systems like the original Turtle trading system worked great, today the opposite is true. Futures charts are full of spikes, at least at times when there are no trends. Surely there are manipulators initiating these false starts, but they probably get supported by so many system traders trying to chase the begin of the next big trend and stumbling into the traps of deep pockets.

  • After FOMC meetings prices of the stock market indices often swing wildly with increasing amplitudes. While this shows that actions of the central bank can be read mostly dualistically - a threatening recession can be good for the market, because interest rates are going to be decreased or bad, because corporate earnings may go down - the method with the two stops on both sides may prove to be deadly in this case.

Forex   Under the millstones of the banks
Futures  Hoping for the trend and finding chaos
Options   Above average? You will still lose!
Stocks   The negative-sum game for investors