Breakout Trading Strategy With S&P 500

Breakout trading strategy is used by active traders and investors to take a position within a trend's early stages. This strategy can be the starting point for major price moves, expansions in volatility and, when managed properly, can offer limited downside risk. 

- A breakout is a potential trading opportunity that occurs when an asset's price moves above a resistance level or moves below a support level on increasing volume.

- The first step in trading breakouts is to identify current price trend patterns along with support and resistance levels in order to plan possible entry and exit points.

- Once you've acted on a breakout strategy, know when to cut your losses and re-assess the situation if the breakout sputters.

- As with any technical trading strategy, don't let emotions get the better of you. Stick with your plan and know when to get in and get out.

Channel within a channel, 2 breakouts in 2 days!

What Is A Breakout?

A breakout is a stock price moving outside a defined support or resistance level with increased volume. A breakout trader enters a long position after the stock price breaks above resistance or enters a short position after the stock breaks below support. Once the stock trades beyond the price barrier, volatility tends to increase and prices usually trend in the breakout's direction.

Breakouts occur in all types of market environments. Typically, the most explosive price movements are a result of channel breakouts and price pattern breakouts such as triangles, flags, or head and shoulders patterns. As volatility contracts during these time frames, it will typically expand after prices move beyond the identified ranges.

Head & shoulders breakouts

When trading breakouts, it is important to consider the underlying stock's support and resistance levels. The more times a stock price has touched these areas, the more valid these levels are and the more important they become. At the same time, the longer these support and resistance levels have been in play, the better the outcome when the stock price finally breaks out.

The easiest consideration is the entry point. Entry points are fairly black and white when it comes to establishing positions on a breakout. Once prices are set to close above a resistance level, an investor will establish a bullish position. When prices are set to close below a support level, an investor will take on a bearish position.

Fakeouts before the breakouts

To determine the difference between a breakout and a fakeout, wait for confirmation. For example, fakeouts occur when prices open beyond a support or resistance level, but by the end of the day, they wind up moving back within a prior trading range. If an investor acts too quickly or without confirmation, there is no guarantee that prices will continue into new territory. Many investors look for above-average volume as confirmation or wait toward the close of a trading period to determine whether prices will sustain the levels they've broken out of.

Profit Taking

When planning target prices, look at the stock's recent behavior to determine a reasonable objective. When trading price patterns, it is easy to use the recent price action to establish a price target.

Use average price swing as profit target

Another idea is to calculate recent price swings and average them out to get a relative price target. If the stock has made an average price swing of four points over the past few price swings, this would be a reasonable objective.

After the goal is reached, an investor can exit the position, exit a portion of the position to let the rest run, or raise a stop-loss order to lock in profits.

Where to Exit With a Loss

It is important to know when a trade has failed. Breakout trading offers this insight in a fairly clear manner. After a breakout, old resistance levels should act as new support and old support levels should act as new resistance. This is an important consideration because it is an objective way to determine when a trade has failed and an easy way to determine where to set your stop-loss order. After a position has been taken, use the old support or resistance level as a line in the sand to close out a losing trade.

Add stop-loss as protection

Setting a Stop Order

When considering where to exit a position with a loss, use the prior support or resistance level beyond which prices have broken. Placing a stop comfortably within these parameters is a safe way to protect a position without giving the trade too much downside risk. Setting a stop higher than this will likely trigger an exit prematurely because it is common for prices to retest price levels they've just broken out of.

Looking at the above chart illustrations, you can see the initial consolidation of prices, the breakout, the retest, and the price objective reached. The process is fairly mechanical. When considering where to set a stop-loss order, had it been set above the old resistance level, prices wouldn't have been able to retest these levels and the investor would have been stopped out prematurely. Setting the stop below this level allows prices to retest and catch the trade quickly if it fails.

Trade #1: 13% gain at 0945

Trade #2: 19% gain at 1015

Trade #3: 14% gain at 1018

Trade #4: 10% gain at 1050

Managed to secure 56% gain with 4 trades under 90 mins from a breakout Friday. 

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