What is a breakout?

11. Apr. 2022

#breakout #Candlestick #TA #Tocademy
Hello. This is Tommy.
The lecture material I prepared today is a concept that must be well informed by TA(Technical Analysis) traders, especially in recent market where untraditional patterns, price actions and trends, as we call ‘scam moves’ occur all the time.

I bet you are familiar seeing retail traders or chart analysts shouting “breakout!”. In order to derive market trends and price action/momentum, we find millions of technical variables such as trendline, channel, Fibonacci retracements, pivot levels, and other indicators, etc. Then we seek for behavior of price action by observing whether these variables are kept valid (not broken) or become invalid as soon as they are broken. Understanding and utilizing this behavior, we make trading decisions by deducting optimal zones to enter position(support/resistance), set stoploss/target price(bottom/top), and statistically giving weights on particular scenarios.

In TA world, breakout means that the price has pierced through certain variables. It is commonly known that when the technical factors are broken, additional price momentum is expected towards the direction of the breakout. As the example above, let’s say that we found a falling trendline that are being formed, meaning that at certain point or area, trendline keeps pushing the price down forming LH(Lower High)s. As soon as the price pierce through the trendline, meaning that the trendline failed rejection, we say “trendline is broken above” and can expect more bullish rally. The direction of the trend would be vice versa when trendline under the price is broken below.

So, we buy when PA is broken above and sell when PA is broken below. That sounds so simple huh?

If it was that easy, everyone would be rich right now. I'm sure most of you reading this post are already aware that it's never easy. Why? It’s simple. In this world, there is no such thing as 100% “breakout”. To put it simply, everything we do based on the technical chart is somewhat relative, abstract, and subjective concept. It’s not like breakout has 100% succeeded, or failed but rather is more like breakout has succeeded in 60~70% chance. In other words, there are more than two possible future cases when we search and utilize breakout behavior.

So, we traders need a reliable standard to statistically quantify the ‘degree of breakout’. The most basic way according to the ‘textbook’ is to consider closing price of candlestick firstly crossing the variable. As the price of the candlestick closes above the trendline as case 3, we give a decent weight on breakout scenario.

However, case 2 is the one that confuses us every time. This is when the price did pierce through the trendline but closes below, usually leaving a long tail as a trace which sometimes is interpreted as a whipsaw. As soon as this happens, we have to admit that the chances and reliability is definitely lower than the case 3. It might be regarded as a false breakout or a noise if the trend continues afterwards and it might not actually. It’s a 50:50 call I would say.

When you encounter case 2, to give you a little tip, try waiting a little more to observe next following candles. If the next following candlesticks keep closing prices below, I would raise the probability that the breakout is a false one. In fact, it is best to just not give any meaning on breakout in case 2. It itself is a risk to confirm whether the breakout is successful, not successfully, or false and thus try not take aggressive trades in this very case.

Thank you for reading my posts. Trade Well!

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