Short Term Trading Tactics – Avoid False Breakouts
The Breakout Is One Of The Most Popular Short Term Trading Tactics In The World
One of the most popular short term trading tactics is trading breakout strategies. Most traders love breakouts because they are simple to find and easy to trade. There is very little in the way of theory and typically breakouts are accompanied by volatility so things happen quickly. Also, many times breakouts are caused by news or other important fundamental announcement that can cause serious momentum in the direction of the breakouts.
The Breakout Method Has The Lowest Profit Ratio Of Any Short Term Trading Tactics
The biggest problem most traders experience with breakouts is the percentage of trades that end up being losers. Unfortunately, the breakout is known for being the strategy that causes traders the most amount of grief. Like most things in trading it’s a double edge sward, the best short term trading tactics usually have the highest number of losers compared to winners.
Imagine for a minute that you can keep all the benefits to trading breakouts but could eliminate the high percentage of losers, wouldn’t that be great?
Well I’m going to show you some data that I’ve collected that will help you do just that, it will help you avoid false breakouts and substantially increase your percentage of winners to losers ratio.
What I did was test about 60 different markets and about 2,500 stocks over the last 30 years, to see which length of breakout causes the least false signals. You would think that this type of analysis would be all over the internet, but it’s not.
Setting Up The Indicators For Breakout Test
The test was very simple, I used a simple moving average with the length of 20 days, 40 days, 60 days, 80 days and 100 days.
I wanted to see what percentage of trades that rallied above the moving average actually stayed above the moving average. I used a simple volatility stop loss level as well as profit target so that the tests were identical across the board. I used an ATR (Average True Range indicator for the volatility levels, I will do another tutorial later this week on using the ATR indicator for stops and profit targets.)
The Results Are In
You may be very surprised at the results, but here they are and they are based on over 30 years of back data history, using commodities, stock index futures, currencies and stocks, almost 2500 hundred stocks were used. Stocks were priced over $30.00 and had an average range above 1.00 per day. I wanted to find volatile stocks so if you try to replicate this test, you may want to consider doing the same.
1. Results for 20 days Simple Moving Average – 29.7 percent profitable
2. Results for 40 days Simple Moving Average – 35.9 percent profitable
3. Results for 60 days Simple Moving Average – 44.3 percent profitable
4. Results for 80 days Simple Moving Average – 51.7 percent profitable
5. Results for 100 days Simple Moving Average 47.9 percent profitable
I was actually very surprised when I saw these numbers, I was expecting the highest percentage of profitable trades to be near the 50-60 day level, but these numbers DO NOT LIE. They are based on statistics, and if you want to create profitable short term trading tactics, you may want to read what I’m about to write. The highest percentile of winning trades peaked at 90 days.
This means that if you want to trade breakouts, you may want to consider using the 90 day simple moving average, because according to statistics it produces an accuracy rate of about 55.9 percent. I was hoping that the longer time frame would help increase profitability even further, but after 90 days the number started going down quickly. You can see that waiting to 100 days only decreases the percentage of profitability.
How Can This Information Help You?
If you are creating short term trading tactics that involve breakouts, this study should be your best friend, you now know the best time frame to trade breakouts that will cause the least amount of false signals, but even more importantly this study provides something even more important for savvy traders.
Look at the percentage of false breakouts that occur when you are trading 20 day breakouts, the number is 29.7 percent, let’s round that up to 30 percent. What this means that on average 7 out of 10 trades involving 20 day breakouts will go against you.
This is incredible news! No not the fact that you have huge amount of losers to winners. Just the opposite, you can now create a trend reversal strategy that uses false breakouts and you can achieve 7 out of 10 winners instead of losers. Remember, strategies that have a large number of losers compared to winners can be reversed to achieve a high amount of winners to losers!
So the next few days I will show you how to use this information to create a profitable trend reversal strategy. You don’t want to miss this so stay tuned for tomorrow’s tutorial.
If one of your short term trading tactics is breakouts, you may want to consider increasing your breakout time frame to 90 days, this is statistically the best moving average length to avoid false signals almost 40 percent of the time or increase your profitable trades close to 60 percent ratio, and if you trade breakouts you know how huge that is.
Don’t miss the next several tutorials if you want to learn to make your own short term trading tactics that work! For more on this topic, please go to: Learn Technical Analysis – The Right Way
All the best,
by Roger Scott