A Breakout Trading Strategy is any strategy that looks to exploit a sharp price move in one direction after an extended period of low volatility.
The theory behind all breakout trading strategies is that the period of low volatility acts as pressure on the price, which is eventually unleashed in a sharp breakout from that trading range.
Breakout trades come in many different forms, and can rely on a variety of different technical indicators, such as volatility, trends, momentum and resistance levels.
The key to any Breakout Trading Strategy is to identify the patterns of low volatility that tend to lead to potential breakouts.
These strategies must also be able to show when the breakout is starting and the direction of the breakout, so that traders can forecast the price movement and avoid false breakouts.
Breakout strategies are effective across any timeframe, but they are most often used by day traders and swing traders, who have the most comfort working across a range of different time periods each day.
Key Takeaways
- A Breakout Trading Strategy is any trading strategy that focuses on sharp price movements after an extended period of low volatility.
- The most difficult aspects of any Breakout Trading Strategy are forecasting the exact moment when the breakout from the price level begins, the direction of the breakout and avoiding false breakouts.
A Breakdown of Breakout Trading Strategies
The essence of any Breakout Trading Strategy is very simple: find periods of low volatility and wait for the breakout.
Volatility is a measure of the price action within a period relative to the average value.
- A price can repeatedly end unchanged across multiple time periods but have extreme highs and lows within those time periods.
This would be high volatility.
- A price can change in one direction for the same small amount every time period but never move in the opposite direction.
This would be low volatility.
Breakout strategies look for periods of low volatility where the price is trapped within a range and repeatedly retreats from support levels and resistance levels.
These low volatility patterns are suggested to coil the momentum of the price like a spring, which will eventually forcefully break out from that key level.
How to Use a Breakout Trading Strategy
Finding periods of low volatility is generally straightforward.
The key to trading breakouts is determining when that low volatility will end in a breakout and the direction that breakout will take, as well as avoiding false breakouts.
There are a range of different breakout strategies that use every technical indicator in the book.
However, they all use familiar patterns of low volatility that offer additional clues as to the timing and direction of the resulting breakout.
The key to a successful Breakout Trading Strategy is not simply finding any period of low volatility, but rather finding periods of low volatility in a familiar price chart pattern that can be analyzed using the appropriate technical indicators.
Cup and Handle
The cup and handle chart pattern is one of the most famous technical analysis patterns, but very few people know that it is actually a Breakout Trading Strategy.
The long fall and then rise of the cup represents an extended period of low volatility.
The price is falling and rising, but only gradually and in steady general directions, which tends to act as a coil on the price.
The cup and handle chart pattern is an excellent Breakout Trading Strategy because it does not require any additional indicators.
Traders can simply observe the chart pattern and forecast that the handle’s downward breakout will occur around the top of the cup.
However, the cup and handle chart pattern can be supplemented with a range of additional indicators as traders desire.
Head and Shoulders
The head and shoulders pattern is another example of a famous chart pattern that is actually a breakout trading strategy.
The 3 peaks of the shoulders and head represent support levels and resistance levels respectively.
The price repeatedly retreats from these resistance levels until it finally breaks out in a downward direction from the low volatility range.
This is another example of a breakout chart pattern that does not require any additional technical indicators.
However, traders often use momentum indicators to estimate the strength of the downward breakout.
The Best Tools for a Breakout Trading Strategy
Breakout strategies are a powerful tool for every kind of trader.
Periods of low volatility occur across all time frames, as do the resulting breakouts from these periods.
Traders need to experiment with a range of charts and technical indicators to find the best breakout strategies for their personal trading goals.
Only a top market research tool offers the kind of analytic platform for traders to develop complex and detailed trading plans like these.
Our top recommendations for market research tools for retail traders are:
Some breakout strategies are so simple that they only require a few basic technical tools.
Some breakout strategies can even be executed simply by looking at patterns on the price chart.
Casual traders looking for simple trading strategies will be well served by looking into some of the simplest breakout trading strategies.
Our top recommendation for basic trading platforms for retail traders is: