Investors trading in breakouts often buy breakouts to new highs or new lows. Many of these breakouts then end up as whipsaws, when the security begins a sharp correction after a sustained trend or reverses the trend itself. If you’re going to be buying breakouts you need to know how you can improve the percentage of winners by identifying stocks that may have a higher probability of success after a breakout. Many technical ideas that can help a trader to do the filtering.
Many filters can be used to screen breaking out stocks for increased reliability of the trend continuing. By using these filters, traders can substantially improve their odds of success in trading breakouts of any kind.
1. The breakout is accompanied by a trend qualifier. In the Level 1 Seminar, we discuss many trend qualifiers – signals that reinforce the trend. Our favorite is RE -Range Expansion. If the breakout day also has an RE or a gap open then so much the better. This could be a real breakout.
2. Breakout stock has higher relative strength verses the Index. This tells us that the stock is outperforming. When a stock breaks out in price and also in its Relative Strength vs. other stocks, it is much more likely to be a true market leader and is more likely to follow through.
3. Breakout-day occurs on strong volume. Strong volume could be defined to mean at least 30% higher volume that its 20 day average, or the highest volume in past 20 days.You definitely want strong volume on the day of the breakout to show significant demand is coming in. Strong volume can also be defined as the very highest volume since the trading range started.
4. Before breaking out, in the trading range, there were signs of accumulation. In its simplest form, an accumulation day is a day that closes higher with the volume also higher than the previous day’s volume. You can also use accumulation distribution indicators to check if the indicator is giving signs of accumulation prior to the breakout.
5. Indicators leading price breakout could be a sign of strength in the stock. This happens when accumulation / distribution or momentum indicators such as the RSI breakout a day or two before prices breakout.
By checking out on such filters, you can screen breakouts to identify the candidates most likely to succeed.