Breakouts occur in all types of markets when a stock price moving outside a defined support or resistance level with increased volume. Experienced traders know that they need to enter a long position after the stock price breaks above resistance or enter a short position after the stock breaks below support. To be safe, open a transaction after the confirmation of a break. You need to wait for the formation of the next candle in the same direction as the breakout.
Algorithm for Breakout Trading Strategy
- Wait for the price to approach the level of support or resistance;
- Pay attention to the candle that breaks the usual pattern and is outside the level;
- Be wise and wait for the confirmation of the signal. Make sure the next candle confirms the breakout;
- Buy an option in the direction of breaking right after the candle closes, confirming the signal.
Buying Put option when breaking the level
Buying Put option when a breakout is on a downtrend
Buying Call option when a breakout is on a downtrend line
Before you get more experience we recommend applying the breakout strategy with caution. You should definitely wait for the confirmation of the next signal because a breakout can be false. For example, a false level break can happen when one candle breaks the power level but closes immediately, however the next candle bounces into the regular price range after the previous candle.
Signs of false breakout:
- It is false when the candle breaks the range only with its shadow and closes up the level;
- It is false when the candle closes at or slightly above/below the range but the next candle returns to the price range before the level.
Example of a false break
If, after breaking a range, a diverted or squatting candle appears, then it can be false. In this case, you should wait for the next candle to confirm your prediction.
To determine the difference between a breakout and a fakeout, wait for confirmation. For example, fakeout occurs when prices open beyond a support or resistance level, but by the end of the day, they wind up moving back within a prior trading range. If an investor acts too quickly or without confirmation, there is no guarantee that prices will continue into new territory. Many investors look for above-average volume as confirmation or wait toward the close of a trading period to determine whether prices will sustain the levels they’ve broken out of.