Break out trading is one of the most profitable trading strategies where you can identify many profitable opportunities in the market. But a deep understanding of the trading principles and the ability to act swiftly is required to master this strategy. This comprehensive guide will open the world for you for break out trading strategies and tips to be profitable immediately. This guide will help both the professional traders and the beginner traders to refine their trading skills. This writing will also equip them with the basic knowledge and tools to unlock the potential of break out trading.
What is break out trading?
Breakout trading is one of the key trading strategies that trades use to take profits from significant price movements. It is done with the help of identifying the key support and resistance levels. After identifying the key levels, the traders wait for the price to break out from these levels. When a break out happens, it indicates that the price will continue to move in the same direction for some times. This brings an opportunity for the traders to take a position and ride the trend with the price.
To use this strategy profitably, it is better to understand the basics of break out trading and the key principles to derive its effectiveness. Let’s go deep into the fundamental concepts that form the foundation of breakout trading.
The basics of breakout Trading
The breakout trading is based on the fundamental concept that as the price breaks from the key support or resistance level, it will continue to move in the same direction. Before breakout, there is a consolidation period where price hover between two points. Traders identify these consolidation areas and then wait for the price to shift sentiment.
Breakout trading is equally applicable in all financial markets i.e. stocks, forex, crypto or commodities. The core idea is to find the right time to enter the market the ride the price trend and get profits from this momentum. This is possible with the help of deep analysis of price charts, and thorough understanding of support and resistance levels and the capacity to see the market trends.
Key principles of Break out trading success
There are some trading principles that set the foundation of successful breakout trading. Let’s look at those principles and how we can apply those in our trading approach.
A. Patience and Discipline
In breakout trading, we follow the approach of sniper trading where patience and discipline are the keys to success. In breakout trading, most of the time we see the market patiently and wait for the proper breakout signals and avoid entering the trade too early. This helps in increasing the probability of entering the right trades at the right time that have higher chances of success.
Many technical indicators are used to depict the breakout signals. So, it is better to confirm the breakout before entering into the trade. This will increase the reliability and help the traders to avoid from false breakouts. Confirm the breakout with more than one indicator. Strength of the signal and the candlestick patterns can also provide additional confirmation that the breakout is truly happing.
C. Risk Management
Managing risk is essential in every kind of trading approach. Traders use stop loss order to limit their losses and heavy draw down from a single trade. Trades also keep their position sizes small with pre-defined rules of how much capital can be dedicated to a single trade. A profitable risk-reward ratio is essential for identifying the area to set the stop loss and profit targets.
By following these core principles, there are higher chances of success in break out trading. Now the next step is how to identify breakout patterns and signals.
Identifying Break out Patterns and Signals
Profitability in break out trading is only possible if you have the skills to identify the breakout patterns and signals. With the help of these patterns, traders can predict the break out before it happens and position themselves accordingly to take the advantages of significant price movement. Let’s analyze most common trading patterns and signals that will help you to be a better break out trader.
1. Breakout from Consolidation
Breakout from consolidation is the most common pattern in break out trading. This happens when the price hover within the invisible boundaries of support and resistance. In consolidation the price moves in a range and there is no clear direction of the trend. Traders wait patiently for the price to break this range and move out of the consolidation phase. As the price move beyond range market gives a signal that there is a potential sentiment shift in the market. The breakout can happen in either direction upward or downward and traders take their long and short positions accordingly.
Now, the point is how we can identify that the market is in the consolidation phase. For that the knowledge of market structure is extremely important. Look for areas where the range is narrowing down and these is decreased fluctuations in the price. This gives us the signal that the market is in consolidation phase and breakout can happen soon. Once the price moves out of the range, the break out occurs. And once the break out occurs, take the trades in the direction of the market. Do not forget to set the stop loss order and setting the profit targets or exit strategies.
2. Breakout from Trendlines
Another powerful tool to identify the breakouts are the formation of trendlines. Trend lines are formed by connecting the series of higher highs and lower lows. The direction of the trend lines depicts the overall market direction. As the price moves beyond these trend lines, it gives the signal that the price is breaking out. Here too the price can break in either direction of the trend line. But the safe idea is to trade the enter the trade if the price is breaking in the major market direction.
To identify and master of this strategy, you first have to draw the trend lines. For drawing the trend lines, identify the major swing points and then connect these swing points. Once the price breaks these trend lines, it gives the signal that the break out is occurring. Take a position in the direction of the trend and set your stop loss and profit targets.
3. Breakout from Chart Patterns
There are different kinds of chart patterns such as triangles, rectangles, and wedges that provide significant information for breakouts. These chart patterns are formed when price moves within a geometric phase which depicts are area of consolidation. It means there is a temporary pause in the trend. When the price breaks from these chart patterns, it often ends in huge price movement that bring profitable opportunities for traders.
Traders are required to learn each of these chart patterns, how to identify and trade them and what are their implications. Once the breakout occurs from these chart patterns, take the position in the direction of the trend with proper stop loss and profit target.
You can have an edge over the market and over other traders by mastering the art of identifying break out trading patterns and signals. Along with that, a solid trading strategy is also necessary to properly execute the break out trades. Now, let’s see some of the trading strategies that you can apply in break out trading.
Breakout Trading Strategies
To be successful in break out trading, a well-defined trading strategy is required that covers many factors like when to enter and exit the trade, risk management and how to foster market conditions. Below are the three most popular trading strategies that can be incorporated into your trading plan.
1. Breakout Pullback Strategy
It is the combination of break out trading and pull back. In this strategy, traders do not enter the trade immediately as it breaks out but wait for the pull back to occur. It gives the trader an extra surety that the break out is real. Though this strategy, traders can catch the momentum of the initial trend by minimizing the risk of false breakouts.
To implement this strategy, first you have to see the consolidation are and wait for the break out. After the break out you patiently have to wait for the pull back. Once the pull back happens and the price again starts moving in the direction of the trend, take a position in the direction of the trend. Do not forget to set the stop loss and set your profit target for higher profitability and minimizing risk.
2. Breakout with Retest Strategy
In this strategy, traders wait for the break out to occur and once it occurs, they wait for the price to retest the breakout level. As the price starts moving in the direction of the trend after retesting the breakout level, they enter the trade. This strategy provides validation of the break out and confirms the strength of the trend.
This strategy can be implemented by waiting for the breakout to occur from a pre-defined support or resistance area. Then wait for the price to retest these support or resistance area. After the break out the resistance area become the support if breakout happens in the upward direction. If the breakout happens in the downward direction, then previous support area becomes the resistance area. As the price test the breakout levels, then these areas become potential points to enter the trade.
3. Breakout with Volume Strategy
If we combine the concept of break out trading with the volume analysis then we make this strategy. In this strategy, traders identify only those break outs which happens with high volume. It indicates that there is a strong market participation in the breakout and there are higher chances that the price will move in the direction of the break out.
To implement this strategy, select the stocks or forex pair that usually have higher liquidity and volume. When these stocks break outs from a consolidation point with higher volume more than the twice of the regular volume then enter the trade in the direction of the trend.
These break out trading strategies provide the foundations of your trading plan. It is worth noticing that no single strategy can guarantee success. Even with the same strategy, few traders are making profits and few are not. It is better to make a customize trading strategy continuously evaluate and update your trading strategy. Your trading strategy should accommodate different kinds of market situations and risk management.
Risk Management in Break Out Trading
Risk management is the core aspect of any trading strategy. Proper risk management help you to protect your capital and avoid from heavy loss in a single go. Here are the most commonly used risk management principles that should be followed while trading with break outs.
1. Stop Loss Orders
In break out trading or any other form of trading, setting the stop loss order is essential. With this order, trader automatically exit the trade if the losses are beyond a certain point or certain market conditions hit. With the help of stop loss order, you limit your losses to go beyond a certain limit and can lose only a limited portion of your capital in a single trade. The stop loss order can be set as per your risk tolerance level or based on your trading strategies under specific market conditions. For example, you can set a stop loss order below a swing point in case of long trade.
2. Risk-Reward Ratio
Risk to reward ratio is one of the most core aspect of trading. If you have favorable risk to reward ratio than you can make money even if the percentage of winning trades is low. Traders normally use 1:2 risk to reward ratio or 1:1.5 risk to reward ratio. In such scenario, even if you are correct 50% of the time, you can still make money in trading. There is a trade off between risk to reward ratio and the winning percentage. If you go for higher risk to reward ration the winning percentage may be low. So, you have to create a balance according to your trading strategy and that is most favorable to you.
3. Proper Position Sizing
Position sizing is the way to determine the appropriate trade size based on risk tolerance and account balance. It includes calculating the number of shares to be traded to ensure that each trade carries a specific risk. With the help of position sizing, trades can control their risk and avoid oversizing a single trade.
4. Avoid Overtrading
In breakout trading, overtrading is a most common drawback. You should trade only high-quality setups that meets your trading criteria. Do not chase the market and avoid all psychological mistakes that trades maker. Be aware of fear of missing out traits that leads to overtrading with poor trading setup. Be very patient and act as a sniper trader and go when the target is very clear and approachable. With avoiding the poor and unnecessary trades, the win rates and profitability can be increased.
Through the implementation of these risk management strategies, trades can protect their capital and increase the chances of success in break out trading. Now, let’s evaluate some technical indicators that can help you to implement your break out trading strategy.
Technical Indicators for Break Out Trading
Technical indicators provide additional confirmation and insights to implement the breakout trading. It is important to mention here that do not rely only on technical indicators but use them as a complementary tool to validate the breakout signals. Let’s see the top three technical indicators that traders use in break out trading.
1. Moving Average
Moving averages are one of the most commonly used break out trading technical indicators. They help in recognizing the trends and support and resistance levels. Moving average can also be used to confirm breakouts. When the price breaks the moving average in the upside direction, it is considered as bullish break out and when the price breaks the moving average in the downward direction, it is considered as bearish break out. When the price stays above the moving average for sometimes it is considered as uptrend and vice versa. The moving averages are equally good in all time frames whether is 4-hour, one-day or one-week time frame.
2. Bollinger Bands
Bollinger band is a technical indicator that also use moving averages to validate the breakouts. It consists of a single moving average and two standard deviation bands. These bands help in identifying the volatility and the breakouts. When the price stays inside the bands, it is considered as silent market. And when the price goes outside of the band, the market is more volatile and a breakout is happened. Trades look at breakouts via Bollinger bands which happens with expanding bands and this indicates a strong breakout signal.
3. Relative Strength Index
The Relative Strength Index or RSI is a momentum indicator that helps in identifying the overbought and oversold conditions. The RSI can be used to confirm the strength of the breakout in break out trading. Those breakouts are considered more valid which happens when the market is in the overbought or oversold condition. In such break outs there is a greater chance that the market will go to a long distance in the direction of the break out.
As we see, these technical indicators can provide extra insights and valuable information that can complement break out trading strategy. However, it is essential to look for only those technical indicators that best suit your trading style and trading strategy.
Common Mistakes to Avoid in Break Out Trading
Although breakout trading is a very profitable trading strategy but still trades make mistakes that should be avoided. Here are some of the most common mistakes that traders make. To avoid from these mistakes will make your chances of trading success greater.
1. Chasing Breakouts
The most common mistake that trades make is chasing the market and all kinds of breakouts. It consists of entering a trade when the breakout has already occurred with the hope to catch the price momentum. But in fact, the time traders enter into the trade, the momentum has already subsided. This in turn leading to a losing trade. Instead of going straight into break out trading, wait for the pullback where market can give you some discount in price.
2. Ignoring Confirmation Signals
While the breakouts are exciting, it is essential to wait for some additional confirmation before taking the trade. In breakout trading, also look for the strength of the breakout and take help from volume or other candlestick patterns to confirm he breakout. This will increase the probability of success in break out trading.
3. Ignoring Risk Management
Ignoring the risk management strategies is one of the most lethal mistakes that trades make. Setting a stop loss order and setting the appropriate position size is as important as taking the trade at break out level. Proper risk management helps in minimizing the potential loss and save your trading account.
Overtrading is also one of the common pitfalls that traders make in break out trading. It is essential to be choosy and take only those trades that meet all the breakout criteria and fall into your trading style. Don’t go for impulse buying. Trade on the basis of logics and not on the basis of emotions. With patience and logic, you can avoid overtrading and increase your profitability.
To avoid these mistakes mentioned above, trades can enhance their break out trading skill and improve their win rate. Now let’s look at some tips that can further enhance your breakout trading skills.
Tips for Improving Break Out Trading Skills
Improving break out trading skills require experience, practice, dedication and continuous learning. Here are few tips that will help you to enhance your break out trading skills.
1. Backtest and Demo Trade
Backtesting involves in testing your trading strategy on historical data and check its performance. With the help of backtesitng, you can check the strengths and weakness of your trading strategy and can improve it accordingly. With the help of demo trading, you can check your trading strategy in risk free and emotions free environment. This will help you to refine your trading skill and gain some confidence before going into the real market.
2. Keep a Trading Journal
Recording all of your trading transactions will help you to monitor your performance over a period of time. Always record your trades, entry and exit points and the reasons for taking those trades and reasons for exiting the trades. By reviewing your trading journal, you can identify your trading strengths and the areas for improvements which will help you to refine your trading strategies and trading style.
3. Continuously Educate Yourself
The most important concept of improving your trading skills is continuously invest your time and energy in learning. Get yourself aware of the latest skills and trends of the market. You are required to continuously update educate yourself with by reading books, taking online courses and attending online webinars.