Breakout Trading Guide: My Favorite Key Setups

Every trader is looking for the perfect setup — the one that’ll increase their odds and make it possible to win most of their trades. The reality is, there’s no perfect setup. Sometimes things go wrong.

But in an imperfect world, there are plenty of good trading setups and strategies.

Breakout trading is one of them. The bonus? There’s more than one way to play a breakout and different types of breakouts present different opportunities. If you want to learn my breakout trading strategies, join the Trading Challenge. It’s the best trading education on the planet, if I do say so myself.

Download the key points of this post as a PDF

What is Breakout Trading?

breakout-trading

Let me define breakout first. What is a breakout in stocks? A breakout is price movement through historical resistance.

For example, recently (January 8) VirnetX Holding Corp. (NYSE: VHC) broke through resistance levels that developed as the stock’s price dropped over the course of several months.

Check out the chart below and you’ll see what I mean:

stock chart breakout
VHC chart: breakout example Source: FreeStockCharts.com

Breakout trading is a set of strategies to take advantage of the price action in the VHC chart example. Now look at the bottom of the chart. Notice the spike in trading volume following the initial breakout? Volume and volatility nearly always spike during a breakout.

The obvious strategy is to buy shares on the breakout and then sell for a profit as the price rises. You might be surprised to know there are other breakout strategies — and sometimes buying the breakout as it happens is not the best strategy.

Benefits of Trading Breakouts?

Like most of the patterns I use, there’s a certain level of predictability when you trade breakouts. It’s the predictability that gives me an advantage.

So far I’ve oversimplified things. There’s a lot to understand with breakouts, so let’s dig in.

Stock Market vs. Crypto Market Breakout Strategies

Trading cryptocurrency isn’t so different from trading stocks or forex in terms of breakout strategies. I wrote a blog post with 5 key tips for the cryptocurrency markets recently. You can apply a lot of the same strategies (including breakout trading) to crypto if it’s your thing.

Be careful — crypto can have massive swings. I’ve traded some crypto stocks but I don’t trade the actual currency. A few of my students are really into crypto trading and they tell me the same patterns from penny stock trading apply to crypto.

How to Implement a Breakout Trading Strategy

Now that you know what they are, let’s take a look at how to trade breakouts.

As with all the strategies I teach, breakout trading should be clearly planned out. You should know what you’ll do in every situation before you go into the trade. I hope this becomes a mantra for you: Plan every trade and follow your plan.

Risk Management Strategy for Traders

Every day-trading breakout strategy I use includes risk management.

Risk management is a big idea — you should spend a lot of time on it if you plan to be a professional trader. It might even be the most important aspect of trading, and one that’s overlooked by a lot of amateurs and newbies.

Risk management can help you control losses — yes, you’re going to lose some trades — and optimize your winning trades. It also gives you a risk vs. reward ratio, providing a way for you to determine whether a potential play is worth the risk or if you should abandon it and move on.

How News Catalysts Affect Breakouts

News catalysts might be the number one thing to consider in any day trading breakout strategy. For penny stocks and micro-caps, news drives price action more than almost anything else. Pay attention to news.

Every single day, I’m looking for the big percent gainers. Then I go search for the news to find out why a stock has spiked. Then I might go over to OTCMarkets.com and do more in-depth research about the news I found. Make sense?

Benefits of Using Breakout Trading Indicators

The VHC chart you looked at above included trading volume at the bottom of the chart. I mentioned that trading volume and volatility often increase right after a breakout. This is important. If there’s a price jump but no increase in trading volume, it’s a good idea to do more research to get a better understanding of what’s driving the price action.

Another important indicator is confirmation of the breakout. I use candlestick charts to trade — there are a couple of strong candle breakout indicators you can use for confirmation.

First, the longer the breakout candle, the stronger the initial move. But I wouldn’t necessarily trust the first candle, no matter its length. It could be an unconfirmed breakout. A fakeout. It’s a good idea to wait for the next candle to confirm the breakout. You might even wait for the third candle depending on the news catalyst, the candle period, and your trading plan.

If my plan is to wait out the breakout and dip buy a later panic (like the billionaire breakout below) then I’m looking for overall breakout range. I also look for possible support levels when the stock pulls back after the initial breakout.

Importance of Chart Patterns

If you’ve read my blog and watched enough of my videos, you know patterns are important to my trading strategy. Your breakout trading strategy should consider historical chart patterns.

I’m more of a history teacher than anything else. What do I mean by that? The same patterns keep coming up over and over again. My lawyers squirm a bit when I say this, but the same patterns often (potentially; nothing is guaranteed) keep repeating.

I love my lawyers. They protect me from myself. Here’s to making them squirm a bit. 😉

My results are not typical. This is not investment advice. Seek the advice of a professional. Blah, blah, blah. Let’s go look at some of my favorite breakout patterns …

Examples of My Favorite Breakout Trading Patterns to Use

Ultimately, how successful you are often depends on how much you study. Here are a few breakout trading patterns you should study. The examples will give you an idea of what to look for as you develop your breakout trading method.

#1 First Green Day Breakout

I almost made this the only breakout to study as part of this post. This is one of my favorite plays right now and it’s something every one of my students should be paying attention to.

As a matter of fact, every chart example in this post, except the last, is a good example of a first green day breakout. And the last is *almost* a first green day.

That’s right! The first chart at the top of the post, first green day, was good for a multi-day run-up. The supernova chart below … yep … first green day works for that one. Flat top charts below? Same thing applies.

What is a first green day? Check out this video I made about it …

When penny stocks end the day on a recent high, and the daily high, there’s a good chance it will either gap up or continue moving up first thing in the morning. Especially if the stock has a history of doing so. These breakouts can last 3 or 4 days before the stock drops again.

#2 The Supernova

This might be my all-time favorite. Supernovas rule! The big price jump in a supernova usually means there’s an overextension of the price action. In other words, the bulls are on fire buying the stock and the price goes up too far and too fast. The result? Almost without fail, it ends in a significant price drop.

Depending on your experience, you could play the supernova both long and short. What do I mean by that? Long means you buy low and sell high. You buy expecting the price to go up and then sell when it does. Shorting means you borrow shares high, sell right away, and then buy shares to pay back when the stock price drops (if all goes well).

Check out the Canbiola, Inc. (OTCMKTS: CANB) chart below. This one is a true penny stock. Notice how the price goes supernova in mid-August (2018) and then falls hard over a few days. That’s classic supernova — and you could’ve played both sides of this if you were prepared.

Canbiola-Supernova-Breakout
CANB chart, 4-hour candlestick: classic supernova breakout Source: FreeStockCharts.com
#3 The Billionaire Investor Breakout

This one works particularly well with penny stocks and micro-caps. This play has been one of the most consistent over the last few years. Imagine a tiny company with a crappy chart over the last year but an exciting idea for a product. In this type of breakout, some billionaire decides the company has potential and makes a big investment.

Billionaire investor breakouts can move a penny stock’s price by 10 times on news of an investment. A billionaire investing in a low priced stock is good news — it’s a powerful catalyst. The way to find these setups is to look on StocksToTrade and find the big percent gainers. Then go find the news and do some research if the catalyst is a billionaire’s investment.

How do you play this? Do you buy the initial breakout? Probably not. You recognize the breakout. Then you see if the stock holds the breakout level. Sometimes these turn into several days worth of morning panics. Then over the course of the day, it slowly moves up toward the initial breakout price.

One thing I want to know when I do my research: Did the billionaire buy at market price? If the billionaire buys $25 million worth of shares at market price, it’s solid guidance about possible support levels. The support levels give you an idea of possible morning panic dip-buys.

How does this work? If the breakout is a spike from $2.50 to $4 per share, you’ll often see a morning panic as traders attempt to lock-in profits. It’s not unheard of for the stock to drop nearly back to the pre-breakout price — say $2.60 or $2.70.

Now, it doesn’t always happen this way, but a lot of times you’ll see the same stock jump back up. Not all the way to $4. But enough that you can buy the dip on the morning panic. You might be able to take 20, 30, or even 50 cents a share profit and then close your position.

If this type of pattern happens several days in a row, it becomes pretty predictable. How long will this go on? It’s safe to say it won’t be forever. But as long as you have a risk management strategy in place, you might be able to take profits several days in a row before you move on to another play.

#4 Flat Top Breakout

A flat top breakout is easy to see on a candlestick chart. The price is flat — the stock trades sideways — for a period of time before the breakout. The sideways trading period can also be a period of consolidation after a previous breakout. Some traders define the flat top breakout this way.

Let’s take a look at two different charts for New Age Beverage Corporation (Nasdaq: NBEV). The reason I want to show you two charts is because I want you to see how one breakout helped establish resistance for a much bigger flat top breakout.

The first chart is from mid-May through June, 2018. The breakout above the flat top resistance line at around $1.89 occurred over a 4 day period. It’s not a perfect flat top, but you get the idea, right?  Sometimes the flat top keeps bumping against a resistance line over and over. Also note: first green day would have been a good overnight position.

NBEV-flat-top-breakout-June-2018
NBEV chart: flat top breakout example June 2018 Source: FreeStockCharts.com

Notice the other blue line up near the $2.43 price range? Look at the chart below to see what this chart looks like when we change the perspective to include the daily candle up to the present (January 2019).

NBEV-flat-top-breakout
NBEV chart: flat top breakout, long time frame, big breakout. Source: FreeStockCharts.com

Now we’re talking, right? See how long the price hung out down there in the $1.85 to $1.90 range? Periodically it had small breakouts testing the $2.45 range. This formed one long flat top over the course of 5 months.

Then…

BOOM! Flat top breakout, huge volume spike, huge volatility spike. NBEV has been on a wild ride ever since. By the way, that second chart is a pretty good example of a supernova, as well as being a flat top breakout.

See how the price dropped hard after the breakout? Typical example of positive price overextension — all the hallmarks of a supernova. Only thing is it popped right back up, so if you tried to short it your timing would need to be perfect to avoid a short-squeeze. Join the Trading Challenge to learn how to do this play. It’s not for beginners.

These two charts give you some perspective about breakouts. It’s a hint, if you will. Look at the history of the stock’s price action. One thing I like to see is a history of spikes. If we panned out even more, you’d see that NBEV had breakouts and breakdowns back in 2017, as well. But nothing like what happened in September and early October 2018.

#5 Triangle, Wedge, and Flag Breakouts

I lumped these together because they are all variations of the same thing. Each of these is a type of continuation pattern. The triangle, wedge, or flag is a period of consolidation after a rise in price. A good consolidation breakout strategy is to wait for confirmation before opening your position.

As the consolidation period stretches out over time, the highs and lows either move within a parallel channel or they converge. This forms the triangle, wedge or flag shape. After the consolidation is the continuation —  sometimes it’s gradual and other times it’s a clean breakout.

Take a look at the Weed, Inc (OTCMKTS: BUDZ) chart below. Notice it’s *almost* a first green day. The yellow line shows the daily high and where it traded after the first five minutes the next day. The blue lines define the flag.

BUDZ-flag-plus-first green-day
BUDZ chart: flag continuation. Source: FreeStockCharts.com

Viewed in this time frame, the breakout after the flag doesn’t look clean. But if you change the time frame to 15-minute candles instead of 5-minute candles, then it looks clean. All the more reason to study hard and learn to read the charts.

Master Your Knowledge With Trading Assistance

As you can see, you need to study up. Join the Trading Challenge if you’re serious about trading. You get access to video lessons, live webinars, one of the best trading chat communities on the planet, my weekly watchlist, breakdowns of the trades I and my top students make, and more.

It’s a great program that can help you become a self-sufficient trader. Did I mention you’ll get access to one of my top students as a trading mentor? That rocks. I so wish I’d had a mentor when I first started. I could have saved myself a lot of pain — not to mention money.

Conclusion

Breakout trading is one of the best plays for beginners and experienced traders alike. But make sure you plan your trade. Know your entry and exit points whether the trade is a winner or a loser. Know the catalyst and the psychology of the trade.

Are you a trader? What’s your experience with breakout trading? Comment below and tell other readers about your best breakout trade. New to trading? Comment below with an “I will learn to recognize breakouts.”

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