Trading Strategy: Breakouts Lesson

In this lesson, you’ll discover how to identify and trade breakouts, the third pillar of our comprehensive trading strategy. We’ll show you why monitoring breakout points is crucial for capitalizing on volatility and momentum, and how market participants use breaking support or resistance levels, trend lines, and chart formations to improve their trading outcomes.

Breakout trading offers several advantages that can increase your chances of success. It provides clear entry and exit points based on price moving beyond defined levels, which helps in planning trades and managing risk effectively. A breakout often signals the start of a new trend or a strong continuation of an existing trend, with the initial movement typically being strong and fast, offering potential for high returns in a relatively short period. Breakouts are often followed by an increase in trading volume, which provides additional confirmation that the breakout is genuine and that there is substantial interest in the asset at the new price level.

We focus on four main types of breakouts in our strategy. First, we monitor the breakout of support and resistance levels, as demonstrated with practical examples on Nvidia stock breaking above $315 in May 2023 and Amazon stock breaking through the $145 resistance level. Second, we look for continuation and reversal patterns, including the breakout of triangles, flags, double tops, and head and shoulders formations. Third, we monitor the breakout of trend lines or channels, and finally, we watch for the breakout of moving averages, particularly the 50 and 200 periods.

Through detailed examples on Tesla, oil futures, Salesforce, Wells Fargo, and Netflix, you’ll see how to implement proper trade management strategies. This includes entering positions at the beginning of the breakout, placing stop loss orders just below (or above for short positions) the breakout point to protect against false breakouts, and setting profit targets using risk reward ratios such as 2 to 1 or 3 to 1. You’ll learn how previous resistance levels can become support after a breakout, and how to adjust your positions as the trade develops.

Each example demonstrates practical entry points, risk management techniques, and how to monitor price behavior after a breakout for confirmation of genuine momentum. You’ll see how the number of touches makes levels more relevant, and how breakouts supported by positive sentiment and buying pressure can lead to new bullish or bearish phases in asset prices.

Video Chapters

00:00 – Introduction to trading breakouts and why they matter
01:06 – Types of breakouts we like to trade
01:57 – Breakouts of support and resistance levels
03:11 – Market structure and chart patterns
04:25 – Trend line breakouts and trade management
08:29 – Moving average breakouts

Key Takeaways

Breakout trading provides clear entry and exit points and is often followed by increased trading volume for confirmation
The four main breakout types to monitor are support and resistance levels, continuation and reversal patterns, trend lines or channels, and moving averages (particularly 50 and 200 periods)
Proper trade management includes entering at the breakout, placing stop loss orders just beyond the breakout point, and using risk reward ratios of 2 to 1 or 3 to 1
Previous resistance levels often become support after a breakout, and vice versa for downside breakouts

Video Transcription

[00:00:00.05] - Speaker 1
The third pillar of our strategy is trading breakouts. We monitor breakout points carefully as they bring volatility and momentum to the price of an asset. Market participants observe breaking support or resistance levels, trend lines or chart formations to improve their strategy. There are several reasons why looking for breakouts can increase your chances of success. Breakout trading provides clear entry and exit points based on the asset's price moving beyond a defined support or resistance level.

[00:00:32.23] - Speaker 1
This clarity helps in planning trades and managing risk. A breakout often signals the start of a new trend or a strong continuation of an existing trend. Investors trade breakouts to capitalize on this momentum, expecting the price to move favorably after breaking past a key level. Trading breakouts can lead to significant profits and if the new trend continues over time. The initial movement after a breakout is typically strong and fast, offering the potential for high returns in a relatively short period.

[00:01:06.03] - Speaker 1
Breakouts are often followed by an increase in trading volume, which provides additional confirmation that the breakout is genuine and that there is substantial interest in the asset at the new price level. This increased volume can further boost investor confidence in the trade. These are the types of breakouts we like to trade. In this lesson, we will show you some practical examples. First, we like to monitor the breakout of support and resistance levels.

[00:01:34.19] - Speaker 1
Then we look for continuation and reversal patterns. An example of these would be the breakout of triangles as well as double tops or head and shoulders. Then we monitor the breakout of trend lines or channels. And finally the breakout of moving averages, in particular the 50 and 200 periods. Let's go into detail with practical examples.

[00:01:57.29] - Speaker 1
First, let's look at breakouts of support and resistance levels. The first example is on the Nvidia stock in 2022. The stock was trading on a range. As we can see from this chart. The price reached a high level at $350 in November 2021 and then during the following months retraced back to $110.

[00:02:19.29] - Speaker 1
During 2023, the price started a new trend and found resistance at $315. In May of 2023, we see a strong breakout with a gap confirmed by high volumes. The strong momentum takes the stock to a new trading range. The growth of artificial intelligence fueled the strong momentum and the start of a bullish trend. The price of the stock almost doubled from this breakout point.

[00:02:47.06] - Speaker 1
A second example is on the Amazon stock. Here we see the resistance level at $145. On the left side of the chart, we can see that this was a previous support that had several touches. The number of touches makes the levels more relevant. The price Retraced and bounced back towards this level, but was rejected on two occasions as we can see here.

[00:03:11.06] - Speaker 1
Then we see a series of retests with a breakout. This signals the start of a new bullish trend with momentum. Now let's look at some examples of market structure and chart patterns. The formations that we look at with more attention are the continuation patterns, in particular the triangles and the flags. In many cases we use reversal patterns such as double tops and bottoms or head and shoulder to locate breakout areas.

[00:03:38.10] - Speaker 1
The first example is on the Tesla stock in 2023. We see a bullish flag formation in the chart. The price during that period traded in a range. The breakout of the pattern brings bullish momentum to the stock and we see the start of an uptrend. Now let's look at an example on oil.

[00:03:56.24] - Speaker 1
And here we see the price of the oil future. We see that the price has been consolidating within a narrow range, forming a symmetrical triangle pattern on the chart. The price eventually breaks out to the upside, indicating a potential continuation of the prior uptrend. Traders might enter a long position following the breakout, setting a stop loss just below the breakout point to manage risk. Trend lines are very important levels that are watched by traders.

[00:04:25.27] - Speaker 1
A breakout of a trendline can cause the reaction of market participants and increase momentum. In this example, we can see that salesforce has been in a downward trend for almost a year marked by a descending trend line on the chart. This trend line is drawn by connecting the lower highs the stock has made over this period, clearly showing the direction of the downtrend. The price of the stock begins to flatten and then retraces back towards the long established descending trend line. We then see a bullish breakout that brings momentum and we see the beginning of an uptrend.

[00:05:01.02] - Speaker 1
From a trade management perspective, we this could be a setup for traders. We enter our long trade at the beginning of the breakout, indicating a potential reversal of the downtrend. A common strategy would be to enter a long position shortly after the breakout is confirmed, perhaps waiting for a slight retracement to test the trendline from above. This support. To manage risk, a stop loss might be placed just below the breakout point or the trend line to to protect against the possibility of a false breakout.

[00:05:32.11] - Speaker 1
Initial profit targets could be set at previous resistance levels or using a risk reward ratio that aligns with the trader's strategy, such as 2 to 1 or 3 to 1 risk to reward. If the breakout is genuine, the stock may continue its upward trajectory as it attracts more buyers. The descending trend line which previously acted as resistance may now serve as a support level in any future pullbacks. Investors would monitor the stock's performance closely after the breakout looking for continued signs of strength and upward momentum. Adjustments to stoploss levels and taking partial profits at predetermined targets could be part of the trade management strategy as well.

[00:06:15.14] - Speaker 1
We can use breakouts of a trend line also during an uptrend. In this case, we want see a trend reversal. Contrarian strategies tend to benefit from the momentum that a reversal can bring. In this example, we see the Wells Fargo stock that has been in a steady uptrend for several weeks. This uptrend is characterized by a clear uptrend line drawn by connecting the higher lows formed over the period showing the path of the bullish sentiment.

[00:06:43.25] - Speaker 1
The stock continues to make higher highs and higher lows result respecting the uptrend line as a support level on each pullback. Traders and investors closely monitor this trendline for signs of continued strength or potential weakness. The price retraces to the uptrend line and we see a breakout to the downside. This can signal a potential shift in market sentiment from bullish to bearish. From a trade management perspective, this could be a setup for traders.

[00:07:13.09] - Speaker 1
We enter our short trade at the beginning of the breakout indicating a potential reversal of the uptrend. We could enter a short position shortly after the breakout is confirmed. To manage risk, a stop loss might be placed just above the breakout point or the trendline. To protect against the possibility of a false breakout. Traders might set profit targets based on significant support levels below the current price, historical price action or a predetermined risk reward ratio such as three to one, ensuring the potential gain justifies the risk.

[00:07:48.10] - Speaker 1
If the breakout signifies a true reversal and not just a temporary dip, the price could continue to move lower allowing traders who entered short positions to profit from the downward movement. The previous uptrend line might act as a resistance in future price movements. Traders would monitor the price behavior after the breakout looking for confirmation of the trend reversal through additional bearish signals or patterns. Adjusting the stop loss to break even or taking partial profits as the price moves in their favor could be part of managing the trade effectively. The last example is the breakout of a moving average Similar to the trend line.

[00:08:29.04] - Speaker 1
Moving averages are closely watched by investors and and can determine the price action of an asset. In this example, we see the Netflix stock. It has been in a long downtrend for several days. Throughout this period, the price has remained below its 200 period moving average. On the daily chart, a condition that many traders interpret as a bearish market phase.

[00:08:51.08] - Speaker 1
The price then incrementally moves closer to the 200 period moving average, which has acted as a strong resistance level during the downtrend. On a significant trading day, the price surges, breaking above the 200 period moving average. This breakout is viewed as a potential indicator of a trend reversal. Traders and investors might see the breakout above the 200 period MA as a bullish signal, prompting them to initiate long positions in Netflix, expecting the upward momentum to continue to manage risk. A stop loss might be placed just below the 200 period moving average or a recent swing low to protect against the price dropping back below this key level, which could invalidate the breakout signal.

[00:09:38.17] - Speaker 1
Profit targets can be set based on historical resistance levels, Fibonacci extension levels or using a fixed risk reward ratio strategy. The breakout is supported by continued positive sentiment and buying pressure. Netflix enters a new bullish phase with the price moving higher in the following weeks or months. The 200 period moving average would then be watched as a potential support level on any pullbacks. This concludes the lesson on creating a strategy trading breakouts.