Breakout trading is one of the most popular trading strategies.
Being quite simple in theory, it remains quite complex and complicated in practice.
In this post, we will discuss 7 steps every breakout trader must follow.
💬And just in brief about a breakout trading itself:
this method aims to spot a key level (it might be horizontal support/resistance or a trend line) and then to trade its occasional breakout, assuming that it will trigger an impulsive move.
1️⃣No surprise, the first task of a breakout trader is the identification of key levels. Preferably, these levels should be spotted on weekly/daily time frames.
Here on US100, I executed structure analysis and identified key levels.
2️⃣Once key levels are spotted, a breakout trader should patiently wait for the test of one of those. His goal is to wait for a breakout.
In that step, many traders fail. The problem is that in order to confirm the breakout, one should have strict & reliable rules to follow. The rules that describe a confirmed breakout.
*I apply the following rule: the breakout of a level will be considered to be confirmed once the candle closes above/below the structure on the highest time frame where the structure is recognizable.
In the picture above, we see a confirmed key level breakout.
3️⃣Once the breakout is confirmed, the next step is to wait for a retest of a broken level. Why retest? Simply because a retest gives a better risk to reward ratio for the trade. And even though there is no guarantee that the price will retest the broken level and because of that some trading opportunities will be missed, in the long run, retest trading produces higher gains.
Following our example, the price has retested the broken level.
4️⃣Opening a trade on a retest, one should know the exact target levels. The levels where the profits will be taken. Again, newbies traders make a lot of mistakes on that step. Remember that your targets must be realistic, they must be based on closest strong structure levels, not on your desired returns.
5️⃣Also, a breakout trader should set a stop loss. And again, a stop-loss level must be safe, it must be set at least below/above a previous minor structure to protect you from stop-hunting.
Stop-loss reflects the point where the trader becomes wrong in his predictions and where the trading setup becomes invalid.
In our example, the safest stop loss will be below a local low. Take profit - next key resistance.
6️⃣Once the trading position is opened and stop-loss & take-profit are set, one should patiently wait. There is no guarantee that the price will start falling/growing sharply after the breakout. The market may start coiling for quite a long period of time before it starts acting.
Breakout trader must be patient, not allowing his emotions to intervene.
Returning to our example, after some time, the market easily reached the TP level and went much higher.
7️⃣Lastly, one should remember that his exit points are stop-loss/take-profit levels. Stop-loss adjustment in case of a position drawdown, preliminary profit-taking, and target extension are your worst enemies. Be disciplined, don't be greedy, and keep your emotions in check.
Here is the example of a breakout trade that I took following the strategy: I spotted a confirmed breakout of a key resistance. The price formed a high momentum bullish candle and closed above the structure.
Long position was opened on a retest.
Target was based on the closest horizontal resistance.
Stop loss was placed below the closest horizontal support.
The market quickly reached the target.
Of course, this 7-steps trading plan is not sufficient enough for profitable breakout trading. There are so many nuances on each step of the plan to consider.
However, let this plan be your initial guideline: learn & follow that and with time, keep elaborating its rules until you become a consistently profitable trader.
Are you a breakout trader?