Breakout Chart Patterns
Hot stock picks often have breakout chart patterns but learn why a top trader on Wall Street says that it is his least favorite pattern to trade.
Breakout stocks are probably not what you think they are. Breakout chart patterns are the last phase that stocks go through. First there is the oversold pattern, next the continuation pattern, and then the breakout chart pattern. Traders that bought on the oversold pattern and continuation pattern often take profits on the breakout chart pattern. This is why stock breakout patterns are Jason Bond’s least favorite swing trading pattern. He does say though that he likes to day trade breakout patterns instead of swing trading the pattern.
The best breakout chart patterns to trade are the ones that come after a long continuation pattern.
Breakout Chart Patterns
Below are the best breakout candlestick chart patterns for trading. These breakout chart patterns should never be used alone but instead with the other fundamental and technical indicators I have talked about in previous lessons. Think of these breakout candlestick chart patterns as a small part of a larger swing trading system.
Falling Wedge Chart Pattern
The Wedge, or sometimes called a Falling Wedge, is a bullish pattern that begins wide at the top and contracts as the price moves lower. A Wedge is a continuation pattern. The Wedge does not give a bull buy signal until the breakout.
Cup and Handle Stock Chart
One of the most popular stock breakout patterns is a Cup with Handle pattern. A Cup pattern can form without a handle in which case it’s just a Cup pattern.
The Cup with Handle is a bullish continuation pattern that marks a consolidation period followed by a breakout.
Cup with Handle Breakout Pattern Trading Tips
|Inner Cup||Usually the biggest breakouts come from charts where the low of the inner cup is at an oversold level on the RSI.|
|Handle||The low of the handle should not exceed a 61.8% retracement. The best breakouts come after short handles with a 38.2% retracement.|
|Entry||The place to buy is on the breakout above the inner cup high resistance.|
|Stop-Loss||A good stop loss is at the handle low.|
Symmetrical Triangle Breakout
The Symmetrical Triangle, also called a Coil, is another continuation pattern. It is a Wedge pattern but without a slope either up or down. As the price range contracts and moves into the apex of the triangle, the volume should drop. This is the quiet before the storm, or the range contraction and consolidation before the breakout.
Symmetrical Triangle Trading Tips
|Distance of Breakout||The widest part of the Symmetrical Triangle often called the opening, is the estimated distance the stock will climb following the breakout. In the chart above, $7 is the high of the open while $4.60 is the low. Therefore, the stock is expected to run $2.40 after the breakout or to $7.90 ($5.50 breakout price + $2.40).|
|Volume||Patterns with low volume in the apex of the triangle and high volume on the breakout, have a tendency to run higher for a longer period of time.|
|52 Week Low||The closer to the 52 week low the Symmetrical Triangle is, the better the pattern is for trading.|
Trading Breakout Chart Patterns
Here is some practical trading advice you will not find in a candlestick chart patterns pdf. Years ago, I use to get killed trying to trade breakout chart patterns. The reason is that breakout chart patterns work during range expansion and a strong uptrending market. But when the market transitions into range contraction and a trading market, breakout patterns become headfakes.
As I stated above, one of the most popular traders on Wall Street right now, Jason Bond, says that breakout chart patterns are his least favorite pattern to trade for swing trading. The reason is that money making chart patterns progress through three phases: oversold, continuation, and breakout patterns. Trading breakout chart patterns means that you are buying a stock after those who bought it during the oversold and continuation pattern phases. In other words, trading breakout chart patterns means that you are always arriving a little late to the party. While breakout chart patterns are his least favorite patterns to use for swing trading, Jason Bond says that breakout chart patterns are his favorite to use for day trading (see Opening Range Breakout lesson here).
Frequently Asked Questions about Breakout Chart Patterns
What is a false breakout in trading?
A false breakout is when price moves through a resistance level but then does not have enough momentum to maintain its direction.
Traders can minimize getting suckered by a false breakout by demanding confirmation of volume on the breakout. In the example above, the negative divergence between price and volume was a warning.
Breakouts are Jason Bond’s least favorite pattern to trade because they can end badly with a false breakout, and even if they don’t, you are always arriving to the party a bit late if your entry is the breakout as you chase the stock higher.
Breakouts are notorious for causing traders to blow up their trading accounts.
In addition to volume divergences, traders use moving averages and other technical indicators to minimize false breakouts.
What is a ADX indicator?
The ADX indicator is the Average Directional Index (ADX) indicator that measures both direction and strength of a trend.
The ADX indicator has a +DI (plus directional indicator) and -DI (minus directional indicator) that form the ADX line.
The solid white line on the ADX indicates whether a market is trending or trading. When the ADX line is rising, a market is trending. When the ADX line is falling, a market is trading. The highest number of false breakouts occur in a trading market (when the ADX line is falling).
When the +DI line (green) crosses above the -DI line (red), it’s a buy signal. When the -DI line (red) crosses above the +DI line (green), it’s a sell signal.
In the chart above, the ADX line is curling up meaning AAU is starting to trend up (because the green line is on top of the red line).
I posted the video below called Trending Vs Trading Markets.
vTheTradesurfer posted the excellent video below called ADX Indicator Video Tutorial.
Erich Senft posted the great video below called Support and Resistance Trading with DMI ADX Indicators.
What determines stock volume?
Stock volume is determined by the number of shares traded during a specified period of time. Volume is a graphical representation of the amount of shares exchanged or traded between buyers and sellers.
A stock’s volume is usually plotted horizontally as a histogram bar at the bottom of a stock chart.
Many stock charting software programs allow you to assign color to volume. In the example above, if the day closed down, the volume is colored red. If the day closed up, the volume is colored green. Most new traders mistakenly think that if the volume histogram bar is colored red, that’s the sell side volume. This is not true. It takes buyers for there to be sellers. It takes sellers for there to be buyers. If you zoom in on an intra-day 1 minute chart, you can see all the different green and red histogram bars that occur throughout the trading day. This is why many traders turn off colored volume because it’s misleading. The volume on a daily chart simply shows the total number of shares that exchanged hands for that day.
Preston Pysh posted the excellent video below called What is Stock Volume.
Why is the volume of shares traded important?
The volume of shares traded is the second most important indicator you have after price. The reason volume is so important is that it confirms trends and chart patterns.
The best way to confirm a breakout is when it happens on rising volume.
A price move up or down, on high volume, usually means the upward move is stronger and will continue longer.
Marketgauge posted the excellent video below called How to Analyze Stocks Trading on Volume.
Market Geeks posted the great video below called How To Trade Volume Spikes.
What does high volume trading indicate?
High volume trading indicates a big fight taking place between the Bulls and Bears over a certain price level.
These big fights or volume spikes at certain price levels mean that those price levels are significant.
In the chart above, notice the significant consolidation levels that usually form after a good Bull versus Bear fight. You can use that consolidation to mark support and resistance lines and then if price breaks above resistance go long, or if price breaks below support go short. Since most of these volume spikes occur at market open, this explains why the Opening Range Breakout strategy often works.
InformedTrades posted the excellent video below called One Simple Way to Use Volume to Trade Stocks.
If all this seems a little complicated to you, fear not. In the video below, you will see a real life example of Jason Bond trading a breakout pattern on OCZ for a 15% profit in one trading day! We will study the daily chart and then watch OCZ in real time on a 1 minute chart. Next, you will hear a lecture Jason Bond did on breakout chart patterns. Enjoy!