Are you a day trader? If yes, then you will definitely find this article helpful as you begin to navigate the world of day breakouts. Today we are going to discuss 4 strategies for how to trade intraday breakouts. Before we jump into the meat of the article, let’s first align on the definition of breakouts and some of their key characteristics.
What are Breakouts?
A breakout occurs when price clears a critical level on your chart.
These levels could be a trend line, support, resistance, or a key Fibonacci level. Remember, levels on your chart are psychological and represent the sentiments of day traders at a respective price level.
When you think of day trading breakouts, what comes to mind? Stocks making daily highs, two-day highs, weekly highs, all-time highs? As you see, breakout means a lot of things to a lot of people. So, why do so many people lose money day trading breakouts? Why are traders constantly buying stocks when they hit intraday highs, only to have them rollover within minutes. How many times have you shorted a stock on a breakdown through a critical support level, go get coffee, come back and see the stock has bounced and you just bought a five-thousand dollar no foam, soy latte? Well, in this article I will give you the "secret" that so many breakout day trading professionals use everyday to take themselves from ordinary to extraordinary.
Biggest Misconception about Day Trading Breakouts
If I buy a breakout or sell a breakdown, I will make money, right? If you believe this statement, immediately contact your broker, withdraw your funds and put them in a savings account. If you follow this system, you will lose money. Often times professional floor traders and the like will wait for stocks to break new lows, look for large buy orders in the tape and then start scooping up every share in sight. This will leave you the novice trader, looking at your screen scratching your head. Asking yourself the question, how did this happen? My technical indicators were in alignment. The stock has been below its simple moving average the last 10 bars. The last 15 bars have been down, now when I put on my short position, the stock has the bounce of its life. If you are ready to end your streak of tough trading days, continue reading.
Avoid Trading During Lunch
In the morning, there is news, earnings, gossip, and a multitude of other reasons that cause stocks to move swiftly with heavy volume. Then around lunch, traders take a step back and begin to digest all of the events from the morning. This does not mean there are no good breakouts in the market, but the odds of finding the stocks that will move are not in your favor. It's a known fact on the street that lunch time trading is for accumulating sizeable positions that you can then unload at some point in the future. That is why, during the middle of the day, stocks go through an endless process of breaking out and failing, over and over again. This process is known as intraday accumulation. Think for a second, if you are attempting to accumulate 200,000 shares of a stock. Could you just run out there and put one large order in the market without anyone seeing you? Maybe on a stock like Yahoo, but this is a much harder task in a stock that is not traded heavily. Well if the trading is light, I'll just put the trade on in the morning. Wrong. If you put the trade on in the morning, you can easily get caught up in the morning volatility and may not get the best price. However, if you wait until the afternoon, you can quietly accumulate shares, 10,000 or so each time you buy, without many noticing. So, if you were doing this, would you want the stock to breakout? Of course not, this would mean you would have to pay more per share. So, instead you keep things quiet and by 2 pm, you have been able to acquire your 200,000 shares, over the last 3 hours, under the radar. So, if you are a smaller trader, why get trapped taking on positions during the accumulation period? Why put yourself through the emotional stress of watching your stock breakout and fail, over and over again? If you only remember one thing from this article, middle of the day is for hedge funds and large institutions to build sizeable positions, not for you to day trade breakouts.
Who is Making Money Day Trading Breakouts
The "secret" for day trading breakouts is knowing when to trade them. Are you ready for this? Are you sitting down? There are only 2 to 3 hours per trading session you can day trade breakouts on an intraday basis. That's right. If you are day trading breakouts, you only have about 2 hours a day where you can make money easily, quickly, without much effort.
What Times Work
The optimum times to day trade breakouts is between 9:45 am and 10:45 am and 2:00 pm - 3:15 pm. Most traders say stay away from the morning and late afternoon trading, because it's too volatile, right? Well, that is partially a true statement, if you just go out into the market putting on trades without any defined rules or systems in place. Below are some basic rules that will help you identify winning breakout trades during these volatile time periods:
- Only trade stocks greater than 30 bucks
- Cheap stocks get cheaper. Often times traders like the idea of trading cheap stocks in hopes of greater returns. What about the inherit risk of trading cheaper stocks, the volatile swings, and not to mention the commissions?
- Do not fade gaps
- Yes gaps get filled. The question is, will it get filled in the timeframe you need it to. If you are day trading breakouts, you need things to happen quickly and precisely. You do not have time to wait around for the stock to act appropriately. Remember, it is always easier to go with the trend.
- Avoid stocks that are up or down more than 5%
- You do not want to get involved with a 50% retracement on a 10% move. That's 5% for those of you keeping count.
- Only trade stocks that have a minimum of 2 dollar price range from the previous days high or low
- Remember, the goal here is to day trade breakouts. The greater the recent trading range, the greater your odds are of being in a stock that has room to trend.
4 Strategies for Day Trading Breakouts?
Now that we have covered the basics of breakouts, we are going to delve further into four breakout strategies you can use when day trading.
#1 - Breakout + Volume Indicator
Again, traders use breakouts as a trigger for entering a stock. But, for how long?
Let’s explore a simple strategy where we leverage the volume indicator as our tool for assisting in trading breakouts.
Above is a 10-minute chart of AT&T from Dec 8 – 9, 2015.
The red line signifies the resistance level of a bearish trend. We have highlighted in the green circle the exact moment AT&T breaks out above the down trend line.
At the same time, the volume with AT&T is increasing in a bullish direction. Thus, we go long with the breakout candle. The next 5 candles are bullish and volume is expanding on the up move. We hold our long until we get the first bearish volume bar with increased volume. This happens after 5 periods and we exit the position as shown in the red circle.
Just to clarify, for a proper exit signal, you want to see the volume increase relative to the last few candlesticks and the price to also go counter to the primary trend. This is an early indication that the impulsive move is in the process of at least slowing down, if not reversing.
This trade brought us a profit of 25 cents per share for less than an hour’s work. Notice that after we exit the market, the price starts consolidating and then drops significantly.
#2 - Breakout + Volume Weighted Moving Average (VWMA)
Another way to analyze volumes with your breakout strategy is to include a VWMA.
Since breakouts occur only a few hours a day with high volume, the VWMA could also prove a valuable confirmation tool.
The reason for this is that during times of high volume, the VWMA will experience a deeper incline and further separate itself from the price.
Conversely, when the price trades closely to the VWMA after a breakout, this can be an early indication that the breakout is a false buy signal due to light volume.
The example below shows how to trade a breakout with the help of the VWMA:
This is the 10-minute chart of Bank of America for the period Dec 3 – 7, 2015. We use a 20-period VWMA. The red line indicates a bearish trend. The trend line is tested 5 times before Bank of America finally breaks out, which is highlighted in the green circle.
The price opens the next week with a gap through the trend line and the VWMA. This is when we go long.
Notice that when the volume is high, the VWMA creates a lot of distance between itself and the price action. However, as the volume begins to dry up, the price hugs the VWMA tightly.
For this reason, the price is more likely to break the VWMA during lower volumes, as the bulls are not stepping in to fuel the next round of buying.
Once the price breaks the VWMA, we exit our long position as highlighted in red above. This position brought us a profit of 36 cents per share for few hours of work.
#3 - Scalping for Breakouts with a Short Period Exponential Moving Average
Since the EMA places a higher emphasis on the most recent price action, the EMA will trigger exit signals well before a trend terminates. While we may miss the lion share of the profits, this strategy allows us to make smaller, consistent gains.
Have a look at the following example, which shows how the EMA breakout scalping strategy works:
This is the 10-minute chart of Twitter from Dec 4 – 7, 2015. We use a 5-period EMA in order to catch the short-term price move. We spot a triangle on the chart and we wait for a candle to close below this support line as an indication of a breakdown.
This happens in the green circle and we open a short position. Four large bearish candles occur after our entry, which is great for our pockets.
After this rapid drop, the price begins to hesitate and eventually breaks the 5-period EMA to the downside. We get four big bearish candles afterwards. After the rapid drop, the price starts hesitating and breaks the 5-period EMA in a bullish fashion, at which point we exit the trade. We were able to capture 51 cents of profit per share for under 90 minutes of work.
#4 - Breakout Price Action Trading
There is another, very simple option when trading breakouts intraday. Sometimes the technical indicators and MAs are just too much. If you don’t like overly complicated charts and you want to keep things simple, you will love the breakout price action trading. Price action trading is one of most straightforward methods for active trading.
This is because you only need candlestick formations or support/resistance levels to make a trading decision. No flashy indicators or oscillators to fret about.
Again, do not use any indicators or moving averages! Let’s review an example, to further illustrate this point:
Above is a 10-minute chart of Facebook from the period Dec 3 – 7, 2015. After a bearish downtrend, the price develops into one of the most famous candlestick reversal patterns – the evening star. The price then breaks out and creates a double bottom formation, where the second bottom was higher than the first.
We create a resistance line above the double bottom formation as our trigger for entering a long position. Once price breaks this resistance level, we go long with our first target equal to double the size of the double bottom formation.
We also draw a trend line in green, which represents support for the up move. We stay in the market until our new trend line is broken, which is indicated by the red circle. This trade brought us a profit of $1.70 per share.
So, which strategy is the best for day trading?
I believe the key to breakout trading success is hidden in the volume present during the breakout.
Thus, I recommend a combination of the first and second strategies.
- Breakouts are one of the crucial aspects of day trading.
- Breakouts occur when the price goes through a crucial level – support, resistance, trend, channel, Fibonacci level, chart formation, etc.
- Breakouts give clear entry points, but they do not provide clear exit points.
- We use different on-chart tools in order to identify exit points when trading breakouts.
- Avoid trading breakouts during lunch time.
- Market volumes are crucial when trading breakouts.
- Two of the best instruments to measure volume during breakouts are the volume indicator and the VWMA.
- The EMA is another great tool for trading breakouts.
- Breakouts + EMA create a strong price scalping strategy.
- Breakouts can be traded with simple price action techniques without any indicators.