Breakout trading: what is a breakout

But what exactly is a breakout? Is the definition subjective and changeable depending on the parameters of the individual trader? How can we place profitable trades with breakout strategies?

Here, we will answer all of these questions but first we musthave an operational definition of breakouts. Essentially, a breakout can be defined as a movement in prices that pierces through a clearly defined level of support or resistance. In many cases, market volumes will increase during these times as a greater number ofinvestors is generally required to push prices to new highs or lows.Volatility also will generally increase in these scenarios, astraders who made investments in the wrong direction are forced toclose their positions. In an upside break up resistance, this tends to propel prices much higher, very quickly. In downside breaks of support, prices tend to decline rapidly in short periods of time. Below, we will show some chart examples of upside breaks of resistance and downside breaks of support. When looking at these charts, keep in mind the similarities that exist here when thinking about the ways support and resistance is defined.

First, a bullish breakout of a resistance level in the S&P 500:

Here, we can see that once the resistance level in the S&P 500 was overcome, prices were able to rise higher, much quickly (i.e. without any “resistance”). Next is an example of a downside breakout:

In this bearish example, we are looking at an oil chart and we can see that once prices fell through a clearly defined support level, prices experienced drastic declines, (i.e. without any “support” to keep prices from falling).

Breakouts in Practice

In practice, the term “breakout” is most commonly used when traders are referring to situations where prices overcome a significant level of resistance or fall through a major support zone. But most experienced traders use other confirmation tools (such as an RSI indicator) in order to avoid falling victim to “false breakouts.”

To accomplish this, traders might watch an upside breakout and then look to see if prices have reached overbought territory in the RSI. If this is the case, it should be viewed as a warning signal, as prices might quickly reverse in the downward direction. Conversely, traders might watch an downside breakout and then look to see if prices have reached oversold territory in the RSI. If this is the case, it should be viewed as a warning signal, as prices might quickly reverse in the upward direction.