This Weekend’s Trading Lesson From TradingMarkets

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):

1. 
   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.

2. 
   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.

3. 
   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.

    

4. 
   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.

5. 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.