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Investors
following a strategy similar to the one I teach here
at TradingMarkets.com, as well as those who follow an O'Neil type
strategy, are apt to be buying breakouts to new highs frequently. If you're going to be buying breakouts
of four-week-plus flags or five-week-plus cup-and-handles, you need to know all
the variables that can help you improve the percentage of these trades that are
profitable and/or can help you highlight stocks that have a higher likelihood of
moving substantially higher following a breakout. Fortunately, there are a
number of technicals that can help a trader in this regard.
This month, we'll cover five technical tools that our research shows help
increase the reliability of a breakout moving in the intended direction. By
putting as many of these as possible together, traders can substantially improve
their odds of success in trading breakouts of any kind. Here are the top five
things we look for on a breakout to help confirm that a substantial move is in
the making (in order of importance):
-
Breakout
day closes over pivot resistance and occurs on a TBBLBG. The most
important variable is the price action made on the day of a breakout. TBBLBG
stands for Thrust Breakout, Breakaway Lap, or Breakaway
Gap. The day of the breakout (a new four-plus week high in price)
should make one of these three runaway price action patterns. For a quick review, a Thrust is a large-range day where
the close is in the top third of the range which occurs on volume higher
than the previous day. A Lap up is a day where today's low is greater than
yesterday's close. A Gap up is a day where today's low is greater than
yesterday's high. (See Figure 1.)
Figure
1.
-
Breakout-day closes over pivot resistance and occurs on strong volume (20% over 50-day MA
or near record volume since the trading range began.) The second
most important variable is the volume action on the day of breakout. You
definitely want strong volume on the day of the breakout to show significant
demand is coming in. Demand volume at least 20% above the 50-day MA of
volume on your breakouts and your odds will improve. Strong volume can also
be defined as the very highest volume since the trading range started. (See
Figure 2.)
Figure
2.
-
Breakout
is confirmed by a higher level of relative strength than occurred since the
trading range began. When a stock breaks out in price and also in
its Relative Strength vs. other stocks, it is much more likely to be a true
market leader and is more likely to follow through. (See Figure 3.)
Figure
3.
-
Prior
to the breakout day, the trading range showed more accumulation days than
distribution days. An accumulation day is a day where prices rise
on volume higher than the previous day. A distribution day is a day where
prices fall on volume higher than the previous day. A strong stock will show
more accumulation days than distribution days during its trading-range
consolidation prior to breakout. The second chart of ACRT is an example. If
you count up-volume days that are more up vs. up-volume days that are down,
there are three more up-volume days that are up than down prior to the
breakout day. (See Figure 4.)
Figure
4.
- One or
more of four volume accumulation indexes breaks out to a new high (new high
prior to trading range) before the breakout day in price. We
use Money-Flow, OBV, William's Accumulation, and Volacc as volume
accumulation indexes (see Science of Trading Course). If you have access to
any of these, check to see that your stock has at least one of these volume
accumulation indicators breaking out to new highs ahead of price. (See
Figure 5.)
Figure
5.
The larger the number of these that
confirm a breakout in price, the more likely that you've got a breakout that
will move in the desired direction. In addition, most of the very strongest
moves following breakout are accompanied by at least 3/5 of these
characteristics.
While these confirmation tools will
help you trade any type of breakout, they work particularly well on high RS high
EPS stocks breaking out to new highs, such as those we trade and those O'Neil
trades. So before you get too excited about a four-week-plus flag or
cup-and-handle breakout in a strong RS and EPS stock in a leading group, check
these five features and be sure you have at least one of these in your favor,
and preferably two or more.
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