The Breakout Trading Strategy - Looking for Breakouts from Support and Resistance Levels
Whatever trading chart software you use or, whichever market you choose to trade in, looking at support and resistance levels can be very useful when making trading decisions. Looking at how the price of a company, commodity, currency or future changes over time can give valuable insight into how the market is likely to trend going forward. This is, of course, what every trader wants to know. Nothing is failsafe when it comes to trading, but support and resistance levels can give a good indication of where the market is likely to turn next and be a useful tool in your trading strategy.
What Support and Resistance Levels are and How to Find Them:
Depending on which timescale you prefer to trade over, open a chart showing how the market has moved over minutes, hours, days or weeks. It doesn't really matter which type of chart you prefer, although most traders tend to use the traditional Japanese candlestick format. Any chart showing the up and down movement of price over time will depict high and low price points, however. Look at the lowest and highest price points shown over the length of the chart.
If the market has been on a long trend up or down, this strategy may not prove useful at this stage. However, if the market has been moving up and down over the course of the timescale shown, it’s likely that there will be peaks and troughs where the price has stopped and turned at the same level. Using the trading chart software facility for drawing horizontal lines, place lines along the top and bottom of the up and down zigzag. The lower line becomes the support level, while the upper line shows the resistance level. In other words, the lines show levels at which the price has consistently failed to break through during recent trading.
Using Support and Resistance to Identify Breakouts and Potential Trades:
You are looking for a breakout from the previous pattern. If the price moves significantly above the resistance line, or below the support line, it is a signal that the market may be about to start moving in either an upward or downward trend. It is wise to wait a while after price has broken through either the support, or resistance, level before placing a trade because false breakouts frequently occur. When the price breaks through the support level, you will be looking to short, or sell, the chosen stock, currency, future or commodity. If it breaks through the resistance level, you will be thinking of going long, or buying, instead.
How to Confirm Buy or Sell Trading Decisions:
When you are pretty sure you have spotted a breakout, there are several ways you can back up your findings before risking money on a trade. Look at technical indicators to make sure they confirm your prediction. There are websites offering free information on how to read technical indicators and technical analysis in general. Learning technical analysis can be a valuable tool in your trading decision-making. It can also be useful to do some fundamental analysis, which involves looking at overall market news, what other traders are saying and doing, as well as looking at individual company performance reports, for example.
How to Protect Your Trading Capital:
It is sensible to place appropriate stop-loss positions when making trades. You are likely to risk more if you are trading over longer timescales, to make the trade worthwhile, and less on more short-term trades. Choose a price at which you think the market will have turned too far for your initial prediction to come true. Although markets tend to move up and down even when moving in one direction overall, if the price reverses too much it is likely that the breakout was a false signal and your trade will fail.
It is also best, before entering any trade to decide where you will take your profit if you win. Again, choose an appropriate level at which you will have made enough profit to make the trade worthwhile, but at which you don’t want to risk losing the money you have already made. Your trading platform will usually have facilities for you to enter predetermined stop-loss and take-profit positions.
Good money management techniques are essential for successful trading. It is generally thought unwise to risk more than 2% of your total trading capital on any one trade. Otherwise too many unsuccessful trades can quickly wipe out a trading account, leaving you with no stake with which to regain previous losses before, hopefully, moving into profit.
Trading is a risky business and no trading strategy is guaranteed. You should never trade with money that you cannot afford to lose. Only a small minority of traders are successful long-term, and most traders lose money in their first year of trading.