How to Identify Breakout Stocks
Trading data suggests that markets range more than they trend. The accepted wisdom is that the financial markets move within limited ranges 70% of the time. Therefore, markets are trending only 30% of the time and this is when traders are most likely to make a profit. If you can find stock breakouts and concentrate on developing trading methods to capitalise on the phenomenon, you are putting yourself in the ideal position to experience capital growth.
This article will explain what stock breakouts are, which stocks are most likely to break out, when and why. Then we will explore how to identify breakout stocks and what techniques exist to help identify breakouts before they occur.
What Is a Stock Breakout?
The breakout is one of the essential concepts in technical analysis. It’s an excellent graphical representation that something has occurred to alter the market’s sentiment towards a stock.
A breakout implies a current trend is over. The price can rise, fall or move sideways after the event, but it rarely resumes precisely the same level and trading pattern visualised before the breakout occurred.
Technical Stock Breakouts
We identify breakouts using technical analysis only, although the event’s probable cause is fundamental news relating to the stock, sector or broader market. For example, a quoted company might publicise a trading update that beats forecasts causing the share price to rise significantly.
Alternatively, if the sentiment for an index like the NASDAQ 100 falls, a stock quoted in the index might fall even if its fundamentals are considered good.
When a stock breaks out, it’s escaping the gravity of a current range, and the security might be reversing any earlier trend to develop a new direction.
Traders use many technical indicators and trading patterns to establish the momentum and direction of breakouts: pennants (flags), triangles, head and shoulders, moving averages, trend lines, support, and resistance levels (pivot points) are among the most popular identification methods.
Traders will also use price action candlestick patterns to reveal breakouts. For example, a series of complete bullish candles with small wicks on perhaps a 1hr chart could supply a clear indication of a sustainable breakout to the upside.
Increased trading volume and associated volatility can also be interpreted as a stock potentially breaking out, and specific technical indicators can help identify the increased trading volume.
Through the MetaTrader community, you can access many custom-made tools that claim to identify breakouts. However, most will be combinations and versions of the standard indicators freely available on your MetaTrader trading platform.
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Popular Technical Indicators to Identify Stock Breakouts
Examples of single indicators which can theoretically be used to identify breakout stocks include:
- MACD (Moving Average Convergence Divergence)
- Bollinger Bands
- RSI (Relative Strength Index)
- ADX (Average Directional Index)
- Moving Average
- Williams Percent Range
- CCI (Commodity Channel Index)
Simultaneously, basic price action candlestick patterns can accomplish the same results proving that breakouts are not tricky to pinpoint.
Pivot Points to Identify Stock Breakouts
Many traders prefer to use pivot points, including the three levels of support and resistance, to visualise and pinpoint breakouts. If the price of a stock breaches R1-R2 or S1-S2, they might consider it a breakout event, mainly if the movement is rapid and occurs during a particular session.
Plotting the pivot points on your charts is a straightforward process, and these horizontal lines are the go-to indicators of many traders who prefer to manage clean charts.
Depicted: Admirals MetaTrader 5 Supreme Edition- Apple Inc. H1 Chart with Admiral Pivot. Date Range: 12 April 2021 - 19 April 2021. Date Captured: 19 April 2021. Past performance is not necessarily an indication of future performance.
How to Identify Breakout Stocks
There are various software screening programmes you can search for that will work with trading platforms such as MetaTrader 4 and MetaTrader 5. These flag up which stocks have moved from the mean when observed over several days. You could concentrate on a series of quoted stocks in a sector you like trading and monitor the movements.
You might consider focusing your attention on a particular index and a sector of shares, for instance, tech stocks in the NASDAQ 100 index, such as the FAATTMAN stocks: Facebook, Apple, Amazon, Tesla, Twitter, Microsoft, Alphabet (Google) and Netflix.
The volume of trading in these tech stocks is consistently high; an army of day-traders has ensured that interest and activity always remain high in Tesla, Amazon, Apple, etc. It’s not unusual for these stocks to break out during the New York trading session. You could set parameters that, if breached, show a breakout.
Fixing your focus on such a group of shares and becoming familiar with their reaction to general bullish or bearish trading sentiment and conditions could form the basis of a breakout trading strategy.
How to Trade Stock Breakouts
Trading stock breakouts requires the same attention to detail, skill and discipline as trading any other market phenomenon. You’re searching for a security’s price to move out of its current trading range and the identification of this change is a simple observational process. Although you can use various technical indicators to pinpoint a stock breakout, candlestick and bar patterns are equally relevant.
A critical skill is to ensure the breakout is sustainable (on whatever time frame you choose) rather than a sudden movement that has no momentum. For example, you should wait for several candlesticks on a low timeframe to confirm the new direction or growth in a current trend before executing your trade.
Basic Rules to Trade Breakouts
- Identify current price trend patterns, support and resistance levels to establish potential entry and exit points.
- Once you’ve executed your trade based on a breakout strategy, know when to exit and take your profits and when to leave and cut your losses if the breakout opportunity doesn’t work out.
- Do not get emotionally attached to your position. Stick to your trading plan. You may have done your homework, all indications might point to a breakout, but the trade fails.
Simple Stock Breakout Trading Strategies
A popular breakout strategy involves the market open. Traders will anticipate a particular stock’s breakout movement when, for example, the New York Stock Exchange opens.
A specific company’s stock may have been subject to speculation during after-market hours, or a futures index may have risen overnight when the markets are closed, creating the ideal conditions for a breakout trade.
Can You Identify Breakout Stock Trading Opportunities Before They Occur?
If you’ve traded for a while, you’ll recognise this scenario—everything lines up perfectly; technical indicators, pivot points, Fibonacci retracement, price action displayed by candlesticks.
You enter the market, the trade moves into profit according to your skilful analysis, but suddenly market sentiment changes and you’re left staring at a loss. The takeaway should be that there are no guarantees for any strategy but protecting your bottom line through strict money management is essential.
We know that probability and risk are critical concepts about trading outcomes, and breakout strategies rely heavily on tight control. You should apply sound money management techniques using stop-losses, take profit limits, and be aware that breakout stock trading techniques require a careful application.
For instance, if you’re looking to trade breakouts at the open, you’ll have short term targets; therefore, your use of stop-losses and limits is more crucial.
Example of a Practical Breakout Strategy
Identify the opportunity. Identify stocks that have traded in a range over recent sessions; these securities will coil to break out if the reasons are valid.
Be patient. Ensure that all your conditions get met before you execute your trade. If the specific criteria are not triggered, then you’ll immediately begin to doubt the trade’s validity.
Realistic targets. Consider using take profit limit orders for your breakout trades. While we all want profits to run, data proves that price rarely reaches R3 or S3. Waiting to hit home runs when you can get to the bases isn’t a long-term, workable trading method.
Market close = trade close. Breakout strategies usually involve trading a movement during a session or the day, and they’re not holdover trades where you remain in a swing for days or weeks. Whether you’re in profit or loss, you might want to consider closing the trade as the session relating to your trade ends. For example, if you’re in a NASDAQ stock trade, exit before or when New York closes.
Exit at the take profit limits you set. Whether you set the limit on your platform automatically or have a pre-set level to exit in mind, ensure you keep to it and don’t let a winning trade turn into a loser. You are managing a breakout strategy to bank pips based on a movement you’ve found; it is a breakout trade, not a long-term investment or position trade.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.