Introduction to trading breakouts

Breakout trading is used by active investors to take a position in a trend's early stages. Generally speaking, this strategy can be the starting point for major price moves, expansions in volatility and, when managed properly, can offer limited downside risk. Throughout this blog, i'll try to walk you through the anatomy of this trade from start to finish and offer a few ideas to better manage this trading style.

One of the most interesting topics in trading, and really throughout many areas of life, is what could be called market randomness or the Random walk where sometimes markets don't follow a standard set of rules and when this happens there would be volatility increases and large price swings.

Every trader worth his or her salt knows that trading against the trend is not a good idea. So it seems logical that the best trading systems would be those that follow the trend: when the trend is going up, take long trades only, and when it's going down, it's time to go short. That being said, you'd think that trend-following systems would have the best win/loss ratios, right?

But no one tells you when to enter and how to enter and where to set the stops to limit your downside risk, the breakout trading is a great strategy which can be used.


So what is a breakout?


A breakout is essentially a price that moves outside a predetermined support or resistance level with increased volume. A breakout trader enters a long position after the instrument's price breaks above resistance or enters a short position after the stock breaks below support.

Once the instrument trades beyond the price barrier, volatility tends to increase and prices usually trend in the breakout's direction. The reason breakouts are such an important trading strategy is because these setups are the starting point for future volatility increases and large price swings. In many circumstances, breakouts are the starting point for major price trends.

The markets are extremely dynamic and in constant flux. This brings in an element of randomness that can create profits for unskilled traders and losses for skilled traders, and it happens all the time.

A trader must also determine when a certain string of losses or profits can be attributed their skill, and when it is random. The only way to do this while you are learning is to approach the markets with a trading plan and risk a small percentage of capital on each trade. In this way the trader can see how a method performs over the long run where randomness becomes less of a factor.

It is also important to remember that even the best traders and trading methods experience strings of losses. Learn how to apply the trading breakout methodology to increase your chance of making a winning trade.