Friday, March 23, 2007

Anatomy Of A Stock Breakout


Here's a great example of a breakout trade for a very short-term stock trader. This is the kind of pattern that can work well in trading competitions, such as the one sponsored by CNBC. First, we look for the opening trading range of the first 15-30 minutes. The opening range tells us how market makers are establishing value for the stock (National Semiconductor, NSM; 5 minute bar chart). Note that the opening range (Point A) is above the prior day's close. That tells us that we are seeing increased value being placed in the stock.

At Point B we see a breakout from the opening range on increased volume. That tells us that large market participants are viewing the stock positively, jumping in to buy at new AM highs.

Point C represents the first pullback from the breakout, as some short-term participants take profits. When we see a shallow pullback on reduced volume, as we do here, it tells us that the higher prices are not attracting significant selling. This sets us up for further upside (Point D).

At each pullback in the stock (the horizontal blue lines), we see how far sellers could knock the issue down. Once we get a new move to daily highs, those blue lines can serve as trailing stops to lock in profits.

The nice thing about such setups is that it only takes a few winners to pay for a number of ideas that chop around and don't do much. A majority of profits will come from a handful of nicely trending trades.

15 comments:

Yaser Anwar said...

great stuff!

Dinosaur Trader said...

Nice, simple analysis Brett. When I see graphs like this, it makes me wonder why I waste so much time and energy trading stocks that are pretty much trendless.

Anticipating a trend just isn't worth it most of the time but I sometimes get stuck trying to "manufacture a trade" when one isn't present.

Thanks.

Brett Steenbarger, Ph.D. said...

Hi Dinosaur,

You raise a great point. It is more important to identify breakouts than to predict them. For short-term traders, it makes sense to focus on where the volume is flowing: that's where the movement will be. Thanks for the note--

Brett

AnaTrader said...

Hi Brett

How timely your post for breakout signals....which is great for trading competitions.

Who knows, I may be a contender but for FX Futures, with a prop house , who has invited me today.

Wish me luck!

Bert Hancock said...

Hi Brett,

Haven't posted any comments lately, but certainly have been reviewing your site frequently.

I'm a bit perplexed at the change in the market and hoping you can shed a bit of light. When we saw the canyon-sized selling in late February, it sure appeared we were headed for a longer correction or downtrend than what could well be the case.

With such high volume on the selling, it would seem institutions must have been selling heavily. Why, in such a short period of time, would they be buying again with any real conviction?

Thanks,
Bert

Thomas said...

Hi Brett
This trade would seem to be good on an index such as Spoos or NQ using your new high low indicator and possibly money flow indicator to confirm the breakout with expanding new highs and volume.

x said...

Dr Brett,
Thanks for your email reply.

In this simple example that you illustrate here, where is a good entry point and stop loss? Do you believe in setting a profit goal or just keep trailing?

Thanks once again.

Brett Steenbarger, Ph.D. said...

Hi AnaTrader,

Best of luck in your new prop trading. May you experience many of your own upside breakouts!

Brett

Brett Steenbarger, Ph.D. said...

Hi Bert,

As I noted in my recent posts, the number of stocks making new lows dried up and the Dollar Volume Flow improved as we made lower lows, which told us that the selling wasn't being sustained across stocks. That usually precedes reversal.

Brett

Brett Steenbarger, Ph.D. said...

Hi Thomas,

You raise a good point: many of these indicators can be viewed together to provide a comprehensive view of what's happening in the market. Thanks for the note--

Brett

Brett Steenbarger, Ph.D. said...

Hi X,

I enter after the initial pullback from a breakout high and I often use the pivot-based targets mentioned in my recent articles and posted to my Weblog as profit goals--

Brett

Bert Hancock said...

Thanks, Brett. And I recall your noting this.
My question is probably more long-term in perspective. I've understood (perhaps not fully correctly) that the big institutions don't generally make transactions quite as frequently, due to their very size.
Still just puzzled as to what would have caused their maneuvering to change considering that they were selling aggressively just a few weeks ago.

Unless the recent buying is coming from other sources more than the "big boys," I kinda find it puzzling these institutions would be right back in and buying in such a short period of time considering their mass selling late Feb/early March.

Thanks

Brett Steenbarger, Ph.D. said...

Hi Bert,

Great question. Large institutions such as mutual funds may not be in and out of the market quickly, but many hedge funds, CTAs, and prop traders (for banks and independent firms) are. Indeed, I've encountered quite a few hedge funds that have become active in high frequency trading.

Brett

Bert Hancock said...

'preciate your answer.
If some of these larger entities are moving in and out with greater frequency, then it seems that very characteristic leaves it far from "settled" that the market's current uptrend will be sustained for very long.

Brett Steenbarger, Ph.D. said...

Hi Bert,

True; the active in and out trading of large participants does provide a degree of uncertainty and risk to markets. As a whole, when money flows are increasing and new highs are expanding, market rises tend to continue.

Brett