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Break Outs
This strategy is an ideal one to use when the trend is ranging or in other words consolidating. Similar to the swing trading strategy, stop losses and take profits are also used here but the timing and placement is quite different. This time round instead timing the correction using the Fibonacci tool, we are going to try to time the break out of a range using a candlestick.
Ok, so let’s get begin….
1) Finding the Range
First of all, the most important thing is to find the range. In the following example you can clearly see that the range was determined by plotting two lines on the chart; support and resistance lines. Notice that in order to plot the lines two peaks (highs) were required and two troughs (lows) were required.
After you have found the range the idea is to time the breakout, either to the upside or to the down side, depending on the direction. For example if the price broke down, then you would enter short where the Red Box is located. If the price broke up, then you would enter long where the green box is located.
On the following example you can see that the after trading in range, the price broke the resistance level, signaling a buy position.
2) Time Your Trade
The important thing in this strategy like any other strategy is not to get faked out. This type of scenario can often happen to new traders who have not mastered this strategy and cannot correctly determine a concrete break out signal. The price begins to break out, signaling an entry to the position, but then reverses and comes back into the range.
To avoid this type of scenario it is advisable to use a margin of security and enter the trade slightly above the break out area.
To help us with this it is advisable to make sure that a fair portion of the breakout candle is out of the range. On the previous example we saw that the breakout candle formed a full body, out of the range, virtually clearing the resistance line. This type of situation signals to us that a buy position is now intact.
3) Stop losses and Take Profits
Even though the same stop loss rules can be used like in the swing strategy system, we will explain here a different approach to place your stop loss. As technical analysis is all about basing your assumptions on the previous price action, we can assume that if the price doesn’t present a full break and comes back down entering back into the range, it will have a high probability of heading back to the support level.
Remember that when a range is formed, the price tends to trade within a level of support and resistance, each time heading in the opposite direction.
For this reason, we can work accordingly;
- Place your stop loss a fraction below the breakout line. Remember there is no point absorbing a larger loss if the price heads back into range.
- Shift the stop loss to your entry point once the price has gained enough distance from the entry point.
- Move the stop loss according to the trend to lock in gains
Regarding your take profit, similar to the swing strategy you can either use an upcoming resistance level or a trend line. Once again, if you recall from the support and resistance lesson, prices tend to get stuck around those levels, so if you see that there is a resistance line coming up, you could use that as your target.
Conclusion
In this lesson we covered the break out strategy, how to identify one, enter and the most important where to put your stop loss and take profit. It is important to remember when using this strategy that perfection takes time and effort, especially when determining your entry point.
In our next lessons we will show you various successful trades that derive from these two strategies. The lessons will give step by step explanations of the reasons behind each trade and more important how to manage the trade.
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