The word “breakout” sounds so exciting doesn’t it? It sure sounded exciting to me when I first started trading. But then I realized that it is much easier (and smarter) to buy pullbacks.
First of all, “What is a breakout?”.
A breakout is defined as a stock price that moves outside of a support or resistance area. You would then buy (or short) the stock once it moves above or below these areas.
But, it is not that easy.
There are three problems with trading breakouts:
1. Failed Breakouts
Let’s break these down (no pun intended!) and I think that you will agree with me that trading breakouts is much easier said than done.
How many times have you seen a stock move up through a resistance area, only to sell off? I’ve seen it happen countless times. This is probably the most frustrating thing about buying breakouts.
Here is an example:
The arrows show a couple of whipsaws. Finally, this stock did breakout, but then it tanked a few days later. Talk about frustrating!
Many times a stock will indeed breakout but then consolidate for a very long time. This ties up your trading capital in a stock that is going nowhere. And, it requires a level of patience that most people simply don’t have (including me).
Here is an example:
Buying the breakouts here would have you waiting for weeks in a stock that isn’t going anywhere.
Many times a stock will breakout and pull right back to the breakout point. So (if you bought the breakout) you are now stuck in a bad predicament…
1. You don’t want to risk taking a loss so you are forced to sell.
2. But, you are selling into weakness when the stock has a high probability of moving in your desired direction!
Take a look at the following chart:
This stock broke out (arrow) and then pulled back right back to where it broke out (circle). That is a bad situation to be in if you bought the breakout. But, it would be a great situation if you bought the pullback.
These are the primary reasons why I think trading breakouts is a losers game. But, I would love to hear about your experience with trading breakouts.
Do you trade breakouts? If so, have you had much success trading them?
Leave a comment below!