You always hear traders talk about taking trades that have high probabilities and when I was first starting out I had a hard time finding a high probability set up that worked with my trading style and personality. That is until I discovered breakouts and the power of buying into momentum. You will never find a perfect setup that works 100% of the time but if you can find a setup that will provide consistent returns then you have found your trading edge.
In this trade example we are looking at a breakout in Facebook (FB) on January 4th, 2017 that ended up working great and never had us down money in the trade. Looking at the 5-minute chart of $FB above you will notice the trend has held the 20-day moving average (teal line) for the entire morning with small pull backs to test it and then would move on to higher prices. Shares found some resistance at the $118.20 level as it tested it twice only to be rejected, but on the third try it broke through and blasted off with well over a point in profit potential.
Anatomy Of A Breakout
When looking for potential breakout trades, you need to look for clear support and resistance levels. Levels that have been tested multiple times only to be rejected. When levels like this form on the chart you can bet that other traders are using that level to place their stops against to protect their positions in case it breaks through, which will increase the buying/selling pressure if it does and this is exactly what we are looking for.
When prices do break through you will want to see a pickup in volume and the tape should also speed up confirming the importance of the level and the likelihood that prices are going to continue through. If you don’t see this happen then you may be getting in at a bad spot and should look to exit at any sign of weakness.
How To Trade Breakouts
There are a lot of different ways to trade breakouts, but one way that I have found to work great is to place stop orders above/below the clear resistance/support levels. In the FB trade above there was clear resistance at $118.20 with a little spike above to $118.25 that got smacked down quickly. I placed a buy stop order just above at $118.26 and was filled on the push through.
Trying to get into a stock that is breaking through an important level can be tough if you don’t have hotkeys or orders already live because prices move very quickly and if you try chasing you could end up with really bad entry prices.
Depending on the stock I am trading, I will sometimes place a stop limit order to help protect against slippage. Stocks with tight spreads and plenty of volume generally won’t have too much slippage but stocks like Netflix ($NFLX) can have 15-20 cent spreads in the morning which can really hurt your entry prices with that much slippage. Granted sometimes you won’t get filled if your limit order gets jumped but it’s better than paying 20 cents more for the stock.
The only thing that would have made me like this setup even more appealing is if it was in the morning where there tends to be more volume and strong price action, but this one worked out great anyways. Keep in mind that this strategy is not just for higher priced stocks but also works great for penny stocks.
