Monday, March 8, 2010

Trading Breakouts

Trading ranges are patterns with a message - Soon enough, prices are going to breakout or breakdown from the range. Such moves out of the range are likely to be profitable.

Consider the issues involved in trading these breakouts. (I mean breakouts and breakdowns when I refer to breakouts.)

1. When do you enter the trade?
a. Immediately on breakout
b. On pullback after a breakout.
c. In anticipation of a breakout while inside the range

Each of the choices has unfavorable consequences.
a. Immediately on breakout - The risk is of a false breakout, which pulls back inside the range.
b. On pullback after a breakout.- There may be no pullback in strong trends. So the risk is of missing the trade altogether.
c. In anticipation of a breakout - This of course runs the risk of not breaking out at all or actually breaking out in the opposite direction.

I have not mentioned the advantages of each of these entries, since readers are likely to undestand the benefits.


So, how do you trade the breakout with assurance?

Answer: Make a considered judgement by qualifying the breakout using independent tools. Then, identify the disadvantages of the entry method, and understand that there is no guaranteed outcome.
Independent tools could mean:
1. What are the other stocks in the industry group doing?
2. Is there a barrier just after the breakout which will prevent the price movement (overhead resistance for example)
3. What is the length of the trading range? A long narrow range could mean a breakout which will not look back.
4. Is price breaking out in the direction of the trend or as a reversal. Trend direction breakouts are usually more reliable.
And so on......

Finally,
A. take the trade
B. Set a stop loss
C. Keep volume at sleeping level
D. Follow your rules with discipline
E. Do not worry about the eventual outcome of this trade. Remember, you will take thousands of trades, so one trade here or there is irrelevant.

And, of course, HAVE FUN.

9 comments:

thomas said...

I don't think c is a good option.

step into the range to wait for the break out could mean a longer than expected waiting period, or worse still break out in the wrong direction.

Student Of Market said...

Sir,

earlier I learned from you that buying or selling on the first pullback after breakout gives one of the best risk reward ratio.

The possibility that the pullback may not come by is there but more often than not, there is a pull back.

I have been trying to condition myself to not take the trade unless I identify a pull back - Slow stochastic is one of the indicators I use for pullbacks. Another advantage of using a pullback is that it forces you to watch the market patiently. At any rate, I believe one must not trade under pressure of missing out an opportunity .. there will always be other opportunities as long as you have managed ur capital well.

Also in my experience, c is the option that erodes capital the most.

All this I have learned from you only, and thank you for that ...

gourv said...

Hello Sir,

Thanks a lot for this blog.only 1 question...C. Keep volume at sleeping level...what would be the ideal % of total capital....???could u please present 1 blog on Money management..??

Thanks a lot&Regards
Gourav

Anuj Joshi said...

Hi Sudarshan ji
Another great article from you!!
Yes trading ranges offer great setups and are fairly easy to identify than other chart patterns like head and shoulders etc (which look different in different time frames)
I have been recently reading about Elliott waves...and made a crude kind of a calculator to predict Elliott wave price projection
While doing research I found that wave 2 retraces wave one ...and prior to that we have ABC corrective wave....all these waves combined broadly, forms a TRADING RANGE...and the we take the range off in the form of wave 3(the biggest wave)
Although I dont trade by EW I am a big fan of Trading Ranges...and you article is enlightening...I will save you article now like many I have done in the past...and keep reading time and again to refresh my memory
Best wishes.

NITIN DAMLE said...

Dear Sir,

While watching nifty charts on daily weelky & monthly time frames it is observed that nifty is in trading market in all these time frames it is overbought on daily & monthly charts could we expect a consolidation & sideways correction before breakout? Pl. comment

men said...

RIL has not been performing off late, any suggestions for an investor is it a buy on declines or avoid completely? What should basically be the difference between an investor and a trader for such stocks?

amitkbaid1008 said...

Sir,

Last two posts from you were much educating ones. I would like to know about using CCI(3) for identification of pullbacks

Thanks

Ravi Chandra said...

Since we're talking about sideways markets and breakouts here's something most of you will find interesting. Great for beginners.

The 3 Dimensional Chart Analysis Process by Martha Stokes - http://forum.equis.com/forums/thread/30537.aspx

Dear Sudarshan would you have anything to say about how to look at the volume action along with price in the Indian markets. Anything in volume or any other indicator which denotes institutional activity or leads price movement. We'd appreciate your inputs on the topic.

Regards,
Neha & Ravi.

shan said...

with stop loss any of these can be opted.