Are you looking for the "Holy Grail" of trading strategies? Something that guarantees a high win rate and easy profits? If so, you might be tempted to try breakout trading. After all, it sounds so promising: identifying stocks, currencies, or cryptocurrencies that are about to break out of their trading range and make a big move, then buying or selling at the right time to make a quick profit.
But here's the thing: breakout trading is like playing a game of whack-a-mole. You might get lucky and hit the jackpot, but most of the time you're just whacking away, hoping to strike it big. And even when you do hit a breakout, it's often a false breakout that quickly fizzles out, leaving you with losses and frustration.
So before you jump on the breakout bandwagon, let's take a closer look at this strategy. In this article, we'll explore the ins and outs of breakout trading, including how to find breakout patterns, the best indicators to use, and how to master the art of breakout trading.
But beware, as we explore the low win rates and false breakouts that make this strategy a risky business. And who better to guide you through the pitfalls and potential of breakout trading than Spitfire Traders?
What is a Breakout Strategy?
At its core, breakout trading is all about capturing momentum. Imagine you're at a stoplight, waiting for the green light to go. You see a car next to you revving its engine, eager to peel out at the first opportunity. As soon as the light turns green, the car accelerates, leaving you in the dust. That's a breakout in action.
In the world of trading, a breakout happens when a stock, currency, or cryptocurrency breaks out of a well-defined trading range, either to the upside (bullish breakout) or downside (bearish breakout). This can happen for a variety of reasons, but the reason is not important.
The idea behind breakout trading is to catch that momentum and ride it for as long as possible. Traders will often set up stop-loss orders to minimize their risk and lock in profits, then let the trade run until the momentum fades or a reversal occurs.
But here's the catch: breakouts are fickle beasts. They can be elusive, unpredictable, and short-lived. And even when you do catch a breakout, it might turn out to be a false breakout, which can quickly reverse and leave you with losses.
So before you get too excited about breakout trading, it's important to understand the risks and limitations of this strategy. In the next section, we'll explore how to find breakout patterns, so you can ffigure out if this strategy is right for you - spoiler, our answers might shock you.
How do you Find Breakout Patterns?
One approach is to use technical analysis tools and indicators to identify patterns and trends that might indicate an upcoming breakout. Think of it like searching for buried treasure. You're scanning the charts, looking for clues and signs that point the way to a hidden gem.
Some traders use indicators to identify breakouts, while others prefer more sophisticated analysis like range trading, support, and resistance trading, or volume analysis. You can also look for chart patterns like triangles, flags, or channels, which can indicate a possible breakout. We've covered these more here.
Of course, finding a breakout pattern is only half the battle. The other half is figuring out if it's a true breakout or a false breakout (fakeout). That's where experience, discipline, and emotional control come into play. A false breakout can be like fool's gold – it looks promising at first, but turns out to be worthless.
One way to avoid false breakouts is to wait for confirmation of the breakout before entering a trade. This means waiting for the stock, currency, or cryptocurrency to actually break out of its trading range, then waiting for a confirmation signal like a high time frame price close above or below the breakout level. This can help reduce the risk of false breakouts but is by no means a 'safe' option.
Which Indicator is Best for Breakouts?
It's a question that many traders ask, hoping to find a silver bullet that will lead them to breakout riches. But here's the hard truth: no indicator is perfect, and relying solely on indicators can be a recipe for disaster - we've got this covered here.
Indicators are like weather forecasts – they can give you an idea of what might happen in the future, but they're not always accurate or reliable. They are lagging, meaning they're based on past price movements, and not always able to keep up with the fast-paced world of trading.
That said, there are some indicators that are commonly used in breakout trading. Moving averages are a popular choice, as they can help identify trends and support and resistance levels. The Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) can also be useful for identifying overbought and oversold conditions. Disclaimer, we don't use any of these popular indicators.
But here's the thing: no indicator is foolproof, and relying solely on indicators can still lead to false breakouts and losses. That's why it's important to use indicators in conjunction with other tools and strategies, such as volume analysis and price action.
Another approach is to develop your own breakout strategy, based on your own observations and experience. This can help you identify patterns and trends that might not be apparent to other traders, and give you a competitive edge in the markets.
How do you Master Breakout Trading?
It's the million-dollar question aspiring traders wanna know, hoping to find the secret to breakout success and finally retire to their own private island (complete with a moat and a pet shark named Finny McFinface).. But here's the thing: Spitfire Traders, a successful trading company, never trades breakouts. Well that's a lie, I traded one breakout back in 2021 but that was the first and only one in 5 years.
Why, you ask? Well, the truth is that breakout trading is one of the riskiest and least reliable trading strategies out there. The win rates are low, and false breakouts are all too common.
But that doesn't mean you can't be a successful trader. In fact, there are many other trading strategies that are more reliable and profitable than breakout trading. The key is to find a strategy that works for you and stick to it.
To master breakout trading, you need to develop a disciplined, patient, and analytical approach. This means studying the markets, testing different strategies, and keeping a journal of your trades. You also need to work on your emotional control, so you can avoid making impulsive or emotional decisions that can lead to losses.
Another important aspect of mastering breakout trading is to avoid common mistakes, such as overtrading, chasing the markets, and failing to set stop-loss orders. By avoiding these pitfalls, you can minimize your risk.
Of course, there's no magic formula for mastering breakout trading or any other trading strategy. It takes hard work, dedication, and a willingness to learn from your mistakes. But with the right mindset and approach, you can become a successful and profitable trader.
What is the Best Time Frame for Breakout Trading?
Wannabe traders often wonder what the perfect time frame is for capturing breakout momentum. They're hoping for a magical answer that will fit every trade, like a one-size-fits-all spandex suit. Unfortunately, the market is more like a pair of jeans: there's no such thing as a universal fit.
The best time frame for breakout trading depends on the pattern or range you're looking at. If you're looking at a shorter-term range, like an intraday chart, then a shorter time frame like 15 minutes might be more appropriate. But if you're looking at a longer-term pattern, like a multi-month channel, then a higher time frame like daily or weekly might be more reliable.
The idea behind using a higher time frame is that it can filter out the noise and false breakouts that can occur on lower time frames. A breakout that occurs on a daily chart, for example, is more likely to be a true breakout than a breakout that occurs on a 5-minute chart.
That said, using a higher time frame doesn't guarantee success. You still need to be able to identify true breakouts and avoid false breakouts, using a combination of technical analysis tools and price action.
Another important factor to consider when choosing a time frame for breakout trading is your personal trading style and goals. If you're a day trader, for example, you might prefer to focus on shorter-term charts and scalp quick profits. If you're a swing trader, on the other hand, you might prefer to focus on longer-term charts and capture bigger moves.
What is a 15-minute Breakout Strategy?
It was a popular trading strategy that aimed to capture short-term momentum by identifying breakouts on 15-minute charts. But here's the thing: any breakout strategy, including the 15-minute breakout strategy, can be risky and unreliable.
The problem with breakout trading is that it's based on the assumption that a stock, currency, or cryptocurrency will continue to move in the direction of the breakout, which is not always the case. Breakouts can be fickle and prone to false signals, which can quickly reverse and leave you with losses.
That said, the 15-minute breakout strategy can be a useful tool for traders looking to capture short-term momentum, especially if used in conjunction with other tools and strategies. The key is to be patient, disciplined, and selective when choosing which breakouts to trade.
But here's the thing: there are many other profitable trading strategies out there that can be more reliable and less risky than breakout trading. The key is to find a strategy that works for you.
At Spitfire Traders, for example, we focus on a variety of strategies, including range trading, volume analysis, harmonic patterns, and Elliott Wave Theory, among others. We believe that by diversifying your trading strategies and tools, you can minimize your risk and increase your chances of success.
How do you get a Strong Breakout?
It's the age-old question that keeps traders up at night, tossing and turning with the excitement of capturing big moves and profits. But here's the tea: a breakout is about as strong as a damp noodle without the right volume and delta behind it.
Volume is the amount of shares, currency, or cryptocurrency that is being traded in a given period. When a breakout occurs on high volume, it can be a strong indication that there is strong conviction behind the move. In other words, it suggests that there are a lot of buyers or sellers in the market who are driving the price in a particular direction. Note I said buyers OR sellers - volume bars don't show us which one is the strongest force, it only shows us the number of trades. The colour of the volume bar only represents the candle's colour, not what's happening within the candle, read on...
Volume alone isn't enough to determine the strength of a breakout. That's where delta comes in. Delta is a measure of the net difference between buyers and sellers at a particular price level. It can help identify whether there is more buying pressure or selling pressure behind a breakout.
If the delta is positive, it means there are more buyers than sellers at that price level, which can be a strong indication of a bullish breakout. Conversely, if the delta is negative, it means there are more sellers than buyers at that price level, which can be a strong indication of a bearish breakout.
So, to get a strong breakout, you need to look for breakouts that occur on high volume and with a positive delta (if it's breaking up). This can help increase the likelihood of a successful trade and minimize the risk of false breakouts.
At Spitfire Traders, we focus on using volume analysis and delta to help identify strong breakouts and avoid false breakouts. We believe that by combining these tools with other strategies, such as harmonic patterns and range trading, we can help our traders become more profitable.
How do you Identify a False Breakout in Trading?
Well, that's a bit like asking a barista to explain the meaning of life in the time it takes to make your latte! There are just too many scenarios to cover in a few hundred words, but I'll do my best to give you a quick and helpful answer.
That said, there are some tools and strategies you can use to increase your chances of identifying false breakouts and avoiding losses. One of the most effective is volume analysis, using orderflow software, also known as footprint charts.
Footprint charts provide a detailed view of the trading activity that occurs within the candles. They can help you identify when breakout traders are trapped, which can be a strong indication that the breakout is false and that price is likely to reverse. This is the type of trade we take every single day at Spitfire Traders, counter trading breakout traders.
For example, let's say that a stock breaks out of a resistance level on high volume. At first glance, it might seem like a strong breakout that is worth trading. But by using orderflow software, you can see that the majority of the buying occurred at the top of the range, and that there are large sell orders waiting just above that level. This suggests that breakout traders are trapped and that price is likely to reverse, making the breakout false.
Of course, using orderflow software and volume analysis requires a certain level of skill and experience. But with practice and training, you can develop the ability to identify false breakouts and avoid losses.
Why do Fake Breakouts Happen?
Only the trading gods know the right answer. The truth is, fake breakouts can happen for a variety of reasons, but they all boil down to one thing: liquidity.
Liquidity is the lifeblood of the financial markets. Without enough buyers and sellers, prices can become stagnant and trading can grind to a halt. That's why large players in the market, like institutional investors and market makers, often use fake breakouts to grab liquidity and fuel their trades.
Here's how it works: let's say that a stock is trading in a tight range, with a resistance level that has held strong for several weeks. A breakout above that level might seem like a strong signal that the price is going to continue rising, which can attract a lot of breakout traders looking to profit from the move.
But in reality, the breakout might be fake, with the price being pushed above the resistance level only to grab liquidity from the breakout traders. Once the orders are filled, the large players can then reverse their trades and push the price back down, leaving the breakout traders with losses.
Of course, not all breakouts are fake, and not all large players in the market engage in this kind of behavior. But it's important to be aware of the possibility and to use tools like volume analysis and orderflow software to identify false breakouts and minimize your risk.
Do most Breakouts Fail?
The simple answer...YES!
That's why, at Spitfire Traders, we focus on range trading instead of breakout trading. Rather than trying to predict when a breakout is going to occur, we wait for the price to reach the top or bottom of the range and then look for trading opportunities within the range.
Why is this a better approach? Well, for starters, trading within the range can be much more profitable than trading the breakout itself. That's because you can have multiple winning trades within the range, while breakout traders may have multiple losing trades before they finally get a win.
For example, a range with 3 touches on the bottom and 2 touches on the top can give 5 winning trades, the final touch might be the actual breakout and that's the trade you lose (as a range trader). 5 wins out of 6, not too bad? But the breakout trader may have attempted to trade breakout on all of those touches IF they crossed the line and therefore could lose 5 trades and win 1. Are you starting to get the picture?
In addition, trading the range can be much less risky than trading the breakout. When you trade within the range, you have a clear idea of where to place your stop loss and how much you stand to lose. With breakouts, on the other hand, the risk can be much higher, as false breakouts and sudden reversals can leave you with losses.
Of course, range trading isn't foolproof, and it still requires skill and experience to be successful. But by focusing on range trading and using tools like volume analysis and orderflow software, you can increase your chances of success and minimize your risk.
Conclusion
In conclusion, breakout trading is a popular strategy among newer traders, but it's not always the best choice. Breakouts have a very low success rate, and false breakouts can be a real challenge to identify. That's why, at Spitfire Traders, we focus on range trading instead, using volume analysis and orderflow software to identify trading opportunities within the range.
By trading the range, you can minimize your risk and increase your chances of success. Rather than trying to predict when a breakout is going to occur, you can wait for the price to reach the top or bottom of the range and then look for opportunities to trade within that range. This can be a much more profitable and reliable way to make money in the markets.
At Spitfire Traders, we offer an affordable course that teaches traders how to use volume analysis and other strategies to trade the range and become successful traders. We also offer free content on our public YouTube channel, which provides helpful tips and insights into the world of trading.
So, if you're looking to become a successful trader and avoid the pitfalls of breakout trading, give it a wide birth.
