How many times have you opened your favorite financial newsletter and read about an instrument setting a new 52-week high, wondering what kind of trade would you be able to put in if you got in before everyone else?
If you have heard about breakout trading, you know how valuable it is to get in early and ride the move from the beginning.
First of all, what is a breakout? In trading, a breakout is when an instrument’s price “breaks out” of some range that it was trading in (the range can be price based i.e. support/resistance or it could be volatility-based, e.g. Bollinger band). The bottom edge of this range is usually called “support”, because it “supports” the price when it falls and “doesn’t let it” slip further, and the top edge is referred to as ”resistance” because the price usually “resists” going further up.
When the price does manage to get through its support or resistance level, that’s called a breakout. What’s important is that a breakout is usually followed by a big move in the direction of the breakout and an increase in volatility, which means it’s a perfect time to trade.
With PsyQuation Market Alerts, you will be the first to know about a breakout. Simply set an N-day high/low alert for the instrument you are interested in, pick a direction (or better yet, subscribe to two alerts to cover both sides), and select the window you are interested in, and you will receive an alert every time the instrument sets a new price record in that window.
To determine the window, study the daily price chart of the instrument and determine the average timespan between breakouts, while rounding down.
Let’s make up an example. Let’s say you’re looking at the chart and you see that there was a breakout 5, 31, 60 and 84 days ago. The timespan between breakouts, then, is 26, 29 and 24 days. The true average would be (36 + 39 + 24) / 3 = 26.3, and after rounding down to the closest available option, we arrive at the window size of 20. This provides the best balance between sensitivity, which means we will not miss a breakout, and a chance of a false positive.
After setting up the alert, you will be the first to know about any breakout and the first to reap the profits from it.
One very important thing to keep in mind is that not all instruments are alike – some behave very differently from others. Experience trading one instrument doesn’t necessarily translate to a different one, that’s why you need to study the instrument you’re trading before placing large trades. For some instruments, a new price record can be a sign of it being overbought, which basically means that it is trading at above its worth, and a correction is imminent. In this case, a contrarian trade (against the direction of the breakout) is the better decision.
But how do you choose which direction to take if you are not experienced with the instrument? This is where our probability table tool comes in. Choose the parameters of your alert and explore the historical price action that followed – up to a year in the future. If most of the time a positive breakout led to a rally (further increase in price), there’s a good chance that the next one will too – use that to your advantage. To get an even deeper look into the market, you can see what kind of price action led up to each event, and compare it to the current situation to determine the most appropriate course of action.
The alert has a limitation in that it will only reliably spot breakouts in a sideways market. To find out what this means and what can be done about it, be sure to read our next blog, about the MA break market alert.
For a detailed tutorial on setting up and using the market alerts, as well as picking the right parameters, check out our tutorial.