Stock Chart Patterns – How To Trade Breakouts
Not All Stock Chart Patterns Are Created Equal
There are hundreds of stock chart patterns traders use to enter as well as exit the market. One of the most if not the most popular entry method is the breakout. A few weeks ago I wrote a short article outlining success rates with breakout stock chart patterns. The basis of the article was to show readers how using different time length to determine breakouts could substantially change your success and failure ratio.
The test was composed of over 2500 stocks and several other futures, commodities and currency markets. The test proved that increasing the length of your breakout from 20 days to 90 days could increase your odds of success from approximately 30 percent to about 56 percent.
To make this simple, the test demonstrated that stocks that remain calm for long periods of time tend to have stronger directional moves that continue in that direction. While markets that remain calm for a short period of time tend to have weaker and less consistent moves in one particular direction after they become active again.
In conclusion, what this tells us is stock chart patterns that are quiet for long periods of time tend to have meaningful moves after the quiet period while markets that have been quiet for a short period of time tend to have more random and less meaningful moves.
The most important piece of information that we gathered from this study was the fact that using 90 days as the breakout length produces the best breakouts and anything below that number or above that number tends to decrease the percentage of profitable trades substantially.
There Are Different Types Of Breakouts
Today, I want to show you how you can improve your odds of success even further. The research I presented to you was performed by a computer that was not taking into account what the stock chart looked like prior to analyzing the data. In other words, the computer program was only looking for stocks that were trading at or above their 90 day price high. What the computer was not analyzing was what the stock did immediately prior to making a 90 day price high.
Take a look at these three different examples. All three stocks are making 90 day price highs but the charts all look completely different.
The stock is clearly trending strongly upwards and breaking above the 90 day price high. Notice how much the stock has already moved up prior to the breakout.
This stock had a reasonable 2 month trading range prior to breaking out. The more trading range a stock has the better and more powerful the breakout. This stock has substantially more trading range than the previous example. Always pay attention to what the stock did prior to the breakout.
This is a great example of a stock going through a nice tight trading range prior to breaking out. You can see it’s still a 90 day breakout; however the stock has been wound up for an extended period of time. Breakouts out of trading tight ranges produce the most powerful and volatile moves in one direction.
Always Look For Breakouts Out Of Extended Trading Range
What you typically want to see is a trading range that lasts anywhere from 45 to 90 days. Notice how the stock stays range bound for almost the entire length of the trading range.
Here is another stock with a trading range that lasts about three months. Always keep in mind that the longer the stock stays calm the better the odds that a meaningful move will occur at some point in the future.
How Can This Information Help You
My goal in creating this tutorial is to get you to begin looking at breakouts from a different perspective. Many traders think all breakouts are just breakouts and they should be treated equally. What you need to pay attention to is the behavior of the stock prior to the breakout.
Remember, the longer stock stays calm the better the odds of a long and meaningful move in one direction. This may sound very basic but you would be amazed at how useful this information can be for traders trading volatility set ups such as breakouts.
So the next you analyze stocks or other financial markets, pay attention to the short term trading history prior to the breakout. By picking stocks that breakout out from tight trading ranges, you decrease your risk of loss and increase your profit potential and that’s what successful trading is all about. For more on this topic please go to: Cup And Handle Pattern Recognition And Chart Analysis and MACD Trading Tactics For Beginners
all the best,
By Roger Scott