The Simple Secret to Trading Breakouts
Let’s take a step back from the action today to talk strategy.
Today you’re going to see a couple of ideal setups you can use to pinpoint your next short-term momentum play.
Short-term breakout trading allows you to forget about whatever crazy economic or political storyline is attracting all the attention on Wall Street. When you’re trading breakouts, the news takes a back seat. Tracking down consistent gains becomes your only concern.
Let’s dive right in.
First, let’s nail down our short-term trading objectives. We want to capture breakout moves that can deliver substantial gains in a matter of days or weeks. So our first task is to narrow our search to stocks that are already in established uptrends.
Of course, a stock’s rise is never perfect. Shares will become overextended and correct along the way to higher prices as buyers and sellers duke it out. But you don’t have to find a picture-perfect chart to trade. If a stock is moving “bottom left to top right,” you’re on the right track.
A simple way to weed out broken, trendless, or falling stocks from your list is to screen for names that are within 5% – 10% of their 52-week highs. That should leave you with plenty of strong candidates — even in a corrective market.
Next, you need to watch for the coil. We want a potential trade’s price range to contract substantially as buyers and sellers search for direction. This range contraction should produce clear support and resistance levels you can annotate with a simple line.
Now it’s just a matter of time before your potential trade triggers. The stock will either smash through resistance and break out, triggering a trade. Or sellers will take control and the stock will fall below support.
Here’s a simplified version of how this process plays out:
Breakouts are rarely perfect. What you’re looking for is an obvious coil and a clear breakout above resistance. That’s your buy zone. Once you catch a breakout, you can ride it for a few days or weeks to grab the meat of a new momentum move.
A few key points to remember for your short-term trades:
1. Tighter mental stops will improve performance
Generally, your best performing short-term trades are the ones that start working right out of the gate. While it’s fine to give longer-term plays plenty of leeway, you don’t have that luxury with short-term trade. If a stock breaks out and immediately retreats below short-term support, there’s usually something wrong. Cash out and move on to your next opportunity.
2. Don’t get bogged down in company details
When it comes to momentum plays, we’re not too worried about the company behind the stock, analyst ratings, or earnings. “Only price pays” is the mantra of a short-term trader. You shouldn’t care if you’re trading stock in a company that widgets or washing machines. Grab the tiger by the tail when price action flashes buy. That’s all you need to know.
3. Watch out for interference
You don’t want to accidentally step in front of a freight train when you’re trading. Always check on upcoming events such as earnings announcements or a decision date from a court or government agency.
Remember, you aren’t trading the news. You’re looking to ride a momentum wave based on price action. That means you want market action to play out free of any trend-busting events.
Next week, we’ll dive a little deeper into the specific patterns you can use to trade breakouts for consistent gains. Stay tuned…
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