An Introduction to Short-Term Breakout Trading

Short term breakout trading is perhaps the most popular strategy for short term traders.

Short term breakout trading is generally a chart-based strategy that lends itself readily to technical analysis techniques and is an easy tactic for beginning and novice traders to grasp.

This article will touch upon the basic ideas of breakout trading, provide some real-world examples of breakout trades, and give you an easy-to-use simple method that you can implement into your trading strategies right away.

Breakout trading refers to prices "breaking out" of either a technical pattern such as a triangle, a consolidation range or trend channel.

The theory of breakout trading is that price momentum will continue to carry the stock far enough beyond the breakout point for the trader to be able to seize a profit. One, three or five minute charts can be used for traders using breakout trading for intraday markets, while daily charts are best for end of day breakout trading.

Breakout trades can be either long or short based on the direction of the break. However, breakout trades will always be with the general direction of prices (i.e., pro-trend) and never against it.

Volume plays a crucial role in choosing breakout trades. A trader should see increasing volume along with the breakout in order to confirm momentum before taking a position. It is important to note that a volume spike at the breakout, followed by a rapid decrease in volume often means that the breakout is weak and vulnerable to failure. Such breakouts should be avoided.

"This sounds like a great way to trade. But just how do I find breakouts?"

When I began my trading journey, it was very difficult to find breakouts in real time, especially in the intraday, which was my focus. Traders have tended to restrict their trading of breakouts to daily charts. Today, it is a far different story. Stock screeners are increasingly built into many trading platforms, and there are resources like the stock screener at Trade-Ideas that intraday traders can use to spot breakouts that are happening in the intraday time frame.

I recently located two examples of classic tradable breakouts in the intraday time frame. One was in Bristol-Meyers (BMY | Quote | Chart | News | PowerRating) and the other was in Intuitive Surgical (ISRG | Quote | Chart | News | PowerRating). The breakout method I used is what I call the 9-minute opening range breakout trade. This is a simple, easy to use, effective method for profiting from breakouts in intraday charts.

The 9-minute opening range breakout works by marking the high of the first 9 minutes of trading with a horizontal line across the chart at that level. The time frame can be any number of different options, but I prefer 3-minute candlestick charts.

When a full 3-minute candle, with increasing volume (but without volume spikes!) breaks above that first 9-minute-high, the trade is executed.

When this line was pierced, the trade was entered at 332. Note the increasing, smooth volume increase at the breakout point. No spikes. This trade yielded over 8 points of profit and was a great example of the power of breakout trading.

My next example is not as extreme. But it is a more typical example of a successful short term breakout trade. The stock is Bristol Meyers.

The high of the first 9 minutes was marked, and the trade entered on breakout at 21.62. Price continued to 21.95 as of this writing, yielding a very nice 35 cent per share profit at the time.

Exits are discretionary once profits are obtained with this method. Many traders like to use trailing stops to allow profits to build. The one hard and fast rule I strongly suggest is that if prices immediately drop back below the breakout line after you enter the position, then close the position.

You can always re-enter once the stock breaks out again. But a failure to continue in the direction of the breakout often leads to losses.

Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.