Welcome back from the holidays!
Last week we went through the first of four extremely important patterns and we were able to understand what the pattern looks like and what parameters are required for the pattern to give us the best chance to succeed. This week we are going to tackle the next important pattern and that is the Bullish Breakout!
When most folks start out in the investing world they are told the old adage buy low, sell high? I am guessing that most of you who are reading this have heard that saying? If you have heard of it then I would also be willing to guess that you have an understanding of the issues that can come with that premise? For example, in 2006 US real estate prices were well on their way to being the highest we have seen in pretty much forever. Take a look at the graph below to see the prices on a percentage basis.
This real estate boom came to us courtesy of lowered credit standards which brought in a flood of people that wanted in on the American Dream, which is to own their own homes. The laws of supply and demand took over at that point, more unqualified buyers and fewer houses mean higher prices for the houses that were available. Now, what does this have to do with the Bullish Breakout you ask? Let me explain if real estate prices were at the highest prices that we had seen in a while then how likely is it that we could buy low and sell high at this point? I am certain that some were buying real estate at lower prices, but I would have to think that most were paying higher prices rather than lower prices, wouldn’t you agree? This brings me to my point about the problem with buying low and selling high, what if there is no low to buy, what does one do? Well, most folks would have to wait for the prices to correct, which brings with it another issue, when will the low prices be back? If anyone knows exactly when that will actually happen, please let me know. 🙂 We can see another example of this right now in the current equity markets, our markets are consistently making new highs and this could be problematic for those trying to buy low and later sell high, yes? All this tongue in cheek is to make the point that if we only bought low and sold high we may be sitting around doing a lot of nothing for a long time. This brings us to the wisdom of trend following traders. Their motto is to buy high and sell higher or to borrow low and buy back lower. This opens up a whole new world when it comes to investing or trading as now you can be more active as you are not waiting around for those rare lower prices to show up. This opens up opportunities to get involved and create profits at any time instead of just one in a while.
This is what the Bullish Breakout is all about. Instead of just waiting for the stocks on our watchlists to pull back so that we have a good quality, higher probability Bullish Retracement setup we can be more active and we can look for a good quality, higher probability setup when our stocks break through one of those key resistance levels we have talked about. The Bullish Breakout is a continuation type pattern. This means that we are continuing in the direction of the trend and that even though resistance may have stalled the movement of the equity temporarily that this breakout confirms that the trend is still intact. It is said in trading that nothing ever goes straight up or straight down and this is where the support and resistance come into play. It is these levels that help us define the patterns we are talking about. Trading is also about energy. The movement of a particular equity takes energy to go from one point to another and this energy is the buyers and sellers moving the price higher or lower depending on direction. It is this energy that builds up at resistance levels that gives the Bullish Breakout its advantage. A lot of the time when we have a Bullish Breakout there can be a pretty strong move once the key resistance level is breached. It is this repeated “pounding on the ceiling” that is the energy building for when the breakthrough actually occurs. Think of a breakout like that scene in Lord of the Rings where the orcs are breaking into the castle with the wolfs head, they bang on those wooden doors until they finally give way and then the orcs spill into the castle in large numbers. This is very common for Bullish Breakouts and the more times the resistance is hit without breaching typically the stronger the move after it breaks.
Just like the Bullish Retracement, the Bullish Breakout has certain criteria that we look for to make sure that this is a quality setup. These features are as follows. We need an uptrend as the name suggests. We also need the price to be trading very near to the key resistance level, within an ATR of the resistance level is ideal. We are looking for specific sub-patterns that give us clues that a breakout may be imminent. These sub-patterns are the cup and handle pattern, high base pattern, ascending triangles and pretty much any continuation pattern. Examples of these patterns are shown below.
In addition to the above-mentioned items, we need a clear area above resistance where the price can move before running into another key resistance level. I have heard this termed “room to run.” Also finding enough room to run in the typical movement of that particular equity is important. For example, if the equity you are looking at typically goes up 10 candles before retracing on average then we would want a lot of that possible movement to be left after breaking the key resistance level so that we can get that high energy move that we are expecting before getting back into an average swing. Finally, we are looking for decreasing volume on the days leading up to the breakout, this tells us that the traders are watching this and getting ready to get involved once the break actually occurs.
The chart below is an example of a Bullish Breakout. You can see that this equity is trying hard to break through the key resistance level. This equity has touched the resistance level several times and is storing up energy for its next big move. This equity is also at all time highs which means there is no resistance level just above it and has some decent room to run.
This sums up the Bullish Breakout pattern. This pattern can be found even when the markets are high and we don’t have to wait for the pullback in price to get into a high-quality trade. Try and find some of these using the aforementioned items and follows the breakouts and you will see that this is a key pattern than when mastered can be very profitable.
Next week we will look at the other side of the coin, the bearish trades. We will delve into the the Bear Retracement. We need to understand these opposite patterns because we know that the markets don’t go up forever.
