In today’s article, we’re going to talk about breakout trading. We will cover some of the best trading tactics used to trade breakouts by professional traders. Breakout trading is one of our favorite entry types when trading the markets. Our team at Trading Strategy Guides has developed the best breakout trading strategy. It tells you right away when you’re wrong, which means that you can minimize losses. You can also read our strategy, how to use currency strength for trading success, for more information.
Minimizing losses is one of the hardest parts to achieve in trading. Although, with our breakout trading strategy, it should be easier to understand. To be a successful trader, you must minimize losses and maximize profits.
To achieve profitability, we encourage you to read our top-notch guide, How to Make Money Trading – 2 Keys to Success. The guide has received a lot of positive feedback from our trading community.
The breakout trading principles taught in this article are universal to all markets. You can apply the same breakout trading techniques to stocks, Forex currencies, bonds, and commodities. You can also apply these principles to the cryptocurrency market, no matter the time frame. If you would like to learn more about Multiple time frame analysis, read our article.
In order to trade breakouts, you need to understand what breakout trading is. This seems obvious, but far too many traders forget about the core basics of breakout trading. For more information, read my personal trading plan reviewed by Kimm Krompass.
Let’s move forward and get into the basics of what breakout trading is and how it can help you make money when trading.
What is Breakout Trading?
In order to understand breakout trading, it is important to remember two types of breakouts. Our team at Trading Strategy Guides has identified two types of breakout trading setups:
- Support and Resistance breakouts
- Swing high and Swing Low breakouts
So what is breakout trading?
Breakout trading is an attempt to enter the market when the price moves outside a defined price range (support or resistance). However, a genuine breakout needs to be accompanied by increased volume.
Read Support and Resistance Zones – Road to Successful Trading, to learn how to identify support and resistance.
A chart speaks more than words can do. Here is what support and resistance breakout trading should look like:
Please take out a piece of paper and a pen. What you’re about to learn next is crucial and needs to be immortalized.
In breakout trading, a genuine breakout is followed by a big, bold candle. The candle closes well above the support resistance level. In the figure above, this can be noticed quite instantly. As a rule in breakout trading, the bigger the breakout candle, the better.
What is breakout trading of a swing high and swing low?
We apply the same rules as the support and resistance breakout trading, but with an additional filter. What is this filter? We only want to breakout trade the setups that offer us the best outcome. This is because not all swing highs and swing lows are created equal.
In this regard, we’re only going to attempt breakout trading the swing high and swing low with a “V” shape form. A “V” shaped swing high is defined by a strong rally, quickly followed by a strong selloff. In reverse, the same is true for a “V” shaped swing low.
A price chart will clear any confusion you have about what a breakout trading with a “V” shape form swing is.
You might believe this in itself is an amazing breakout trading strategy. Even without adding anything else to the strategy. But this isn't true. The biggest downfall with breakout trading is that there are too many false breakouts.
Our team at Trading Strategy Guides has developed the best breakout trading strategy. The strategy differentiates a false breakout and a genuine breakout. We have tested many technical indicators to develop the best breakout trading strategy. No matter how much backtesting we have done, one technical indicator always comes first.
Before we move forward, we must define this mysterious technical indicator. You'll need to understand how to use it for the best Breakout Trading Strategy:
The only indicator you need is the:
Volume Weighted Moving Average (VWMA): The VWMA is a simple technical indicator used for volume analysis. The VWMA is one of the most underused technical indicators only professional traders use. VWMA looks like a moving average, but instead, it is based on volume. It’s not just a price based moving average.
The VWMA is located on most trading platforms. Once it is applied to the chart, it should look like the figure below:
Let’s see if it’s a good idea to trade breakouts.
What are the Pros and Cons of Breakout Trading?
Like with any type of trading styles, breakout trading has its own unique advantages and disadvantages.
Trading would be too easy if you wouldn’t encounter drawbacks.
Absolutely there is nothing that has no disadvantage!
And, breakout trading has its unique pros and cons.
Advocates of breakout trading can quickly point out the following advantages:
- The profit potential is instant – profits are made fairly quickly as breakouts can lead to aggressive price movements
- Breakout trading uses the power of momentum
- Has the potential to catch the start of a new trend
- Provides clear trade management rules – entry and exits are predefined
At the same time, if you have been screwed over and over again by false breakouts you can easily point out to the other side of the coin.
It doesn’t feel good to buy the high of the day or to sell the low of the day due to a false breakout.
It’s known that the main disadvantages of breakout trading are the fakeouts.
Because of the increased volatility created by the breakout setup, it can be challenging to enter the market without slippage.
How do you identify high probability breakout trade setups and avoid fakeouts?
This and much more will be answered in the next section.
How to Confirm Breakout Trading
For the inexperienced trader, price analysis isn’t enough to confirm a breakout trade. A good confirmation tool to evaluate the quality of a breakout is the MACD indicator or any other breakout trading indicators.
Or, you can confirm breakout trading with volume profile.
If you want to learn how to confirm a stock breakout, then we suggest trying the volume profile indicator, which has more relevance in the stock market.
However, the MACD indicator is more accessible and it is a great way for a trader to enter a breakout in the early stage of the breakout setup.
Even if you have confidence and faith in a breakout setup, it will not save you from potential fakeouts.
You still need to have some sort of risk management technique and other ways to confirm breakouts.
Our secret favorite way to identify breakout trades right before they happen is to look for clues from the price action.
Our breakout technique requires some time to train your eyes.
Let me explain…
The biggest thing we like to look after is tight consolidation at key support and resistance levels.
See the chart below:
In this area price moves within a narrow range, which often leads to explosive breakouts.
When you see the range of the candlesticks getting smaller and smaller and compressed within a tight box-like price action, something has to give in and break under the pressure just created.
Now, before we go any further, we always recommend taking a piece of paper and a pen. Then note down the rules of the best Breakout trading strategy.
Let’s get started.
The Best Breakout Trading Strategy
(Rules for a Buy Trade)
Step #1: Identify a clear price range or a “V” shape swing high and mark that price level on the chart.
The first step of the best breakout trading strategy requires identifying the price level. It can ultimately be your breakout trading level. This is the most important part when attempting breakout trading. This is why we only want to recognize significant and clear levels.
Do you want to boost your knowledge in identifying these levels? We recommend spending 5 minutes to read, Support and Resistance: What Is Going On at These Critical Areas. This article will teach you methods to help identify the right support and resistance level.
EURUSD 1-Hour Chart
The resistance level we have identified in the figure above is significant. If you look closely, you'll notice each rejection off of the resistance level left behind a minor “V” shape swing high. We had strong rallies that quickly faded away.
These findings bring us to the next step of our best breakout trading strategy.
Step #2: Wait for a break and a close above the resistance level
Once the resistance level has been identified from there on, it’s just a game of patience and waiting.
We need a breakout and breakout candle to close above our resistance level. This is a sign that the bulls are in control.
But we’re not done yet. We still need confirmation from the VWMA indicator. This will give us the green light to pull the trigger on this breakout trading.
Step #3: Buy at the breakout candle closing price only if the VWMA is stretching up.
The final step of the best breakout trading strategy is the needed confirmation from the VWMA. We need to visually see the VWMA stretch up. And the moving average needs to have a deeper inclination to the upside.
Let’s check this on the price chart.
This can be clearly visualized on the price chart. Prior to the breakout, the VWMA only gradually moved higher after the breakout happened. We saw the VWMA aggressively moving higher, which showed a strong presence of volume behind the breakout.
After we bought, we still needed to define where to place our protective stop loss. We also needed to know where to take profits. This brings us to the next step of the best breakout trading strategy.
Step #4: Place your SL below the breakout candle and take profit when you see a break below the VWMA.
It was obvious to place our protective stop loss just below the breakout candle. This is because once we break below the candle that initiates the breakout, it proves to us that this is a false breakout. No real buying is taking place, so we better back out of the trade.
Our take profit technique is intuitive because a break below the VWMA suggests there are no more buyers to sustain the current rally. We want to book the profits at the early sign the market is ready to roll over.
Note** The above was an example of a buy trade… Use the same rules – but in reverse – for a sell trade. In the figure below, you can see an actual SELL trade example, using the best breakout trading strategy.
Breakout Trading FAQ
Is Breakout Trading Profitable?
Breakout trading can be a very lucrative career to make quick profits. To be a successful breakout trader you need to learn the anatomy of a breakout and to be able to recognize false breakouts in order to avoid losses.
Does breakout trading work?
Breakout trading works in any type of market conditions and if done correctly, breakout trading can lead to consistent results. Some of the most effective types of breakouts are a result of trading range breakouts, channel breakouts, triangle breakouts, flag breakouts, support and resistance breakouts etc.
What is the best breakout trading book?
One of the best breakout trading books is “How I Made $2,000,000 in the Stock Market” by Nicolas Darvas. This is an excellent trading book written by a retail trader just like you with an easy to follow “box” breakout trading strategy.
Which one is better breakout trading vs swing trading?
Breakout trading is better than swing trading because oftentimes a breakout can lead to large price swings or major price trends. Swing trading breakout is usually done in harmony with the long-term trends.
Final Thoughts - Breakout Trading
One of the main advantages of the best breakout trading strategy is that you’re trading with momentum on the back. This means two things: instant gratification. Secondly, you’ll learn fast whether or not your breakout trading idea will work.
We have one final tip. If the breakout has as a catalyst a big new risk event, then it’s more likely that big institutional money is behind this breakout. When you have the technicals and the fundamentals working for you, the trade success profitability increases. Below is another strategy called trading volume in forex.
Our step by step guide into news trading can be very helpful here, so please don’t miss the opportunity to read it.
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