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The Traders Wheel
4/11/98 by Alan Farley


Breakout Trading

Significant declines evolve into long bottoms characterized by failed rallies and retesting of prior lows. As new accumulation slowly shakes out the last crowd of losers, a stock's character changes. Prices push toward the top of key resistance. Short-term relative strength improves and charts print a series of bullish price bars with closing ticks near their highs. Finally the issue begins a steady march through the wall marked by previous failures.

Stocks must overcome gravity to enter new uptrends. Value players build bases but can’t supply the critical force needed to fuel rallies. Fortunately, the momentum crowd will arrive just in time to fill this chore. As a stock slowly rises above resistance, greed rings a loud bell and these growth players jump in all at the same time.

The appearance of a sharp breakout gap has tremendous buy power. But the skilled trader should remain cautious unless the move is accompanied by heavy volume. Bursts of enthusiastic buying should draw wide attention, which ignites further price expansion. When volume fails to show, the gap may quickly fill and trap the emotional longs.

Non-gapping, high volume surges provide a comfortable price floor similar to gaps. But support may be more difficult to measure. And momentum can take longer to develop, forcing a stock to swing into a new range rather than rise quickly. Fortunately this scenario also sets up pullback trades as support forces profitable bounces.

The uptrend terrain faces predictable obstacles marked by Clear Air pockets and congestion from prior downtrends. These barriers force frequent dips that mark good buying opportunities. The trader must identify these profitable zones in advance but also recognize that dips will disappear during the strongest rallies. Here price blasts through prior resistance as enthusiasm explodes.

During uptrends, one goal is to locate runaway expansion moves. As trend builds momentum, both gapping and non-gapping surges will register on technical indicators, such as MACD or ADX. Short pullbacks should not violate the math of this developing strength. As volatility absorbs each surge, more powerful rallies should erupt. During these events, price range and volume will expand bar to bar, often culminating in a second (continuation) gap and a final exhaustion spike.

aapl.gif (5942 bytes) Gap breakouts are more likely to rise toward higher prices immediately than simple volume breakouts. Waiting for a dip may be futile. Extreme crowd enthusiasm ignites continued buying at higher levels and market makers don’t need pullbacks to generate volume. If entry is desired, use a trend-following strategy and manage risk with absolute price or percentage loss stops.

 

 
Article contributed by The HARD Right Edge, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission.
 
 

 

 
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Last modified: April 02, 2001

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