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.
