Breakout trading is a strategy that aims to catch significant price movements when a stock breaks through established support or resistance levels. When executed correctly, breakout trades can capture the beginning of powerful trends and deliver substantial profits.
What is Breakout Trading?
A breakout occurs when price moves beyond a defined level that previously acted as a barrier. This barrier can be:
- Horizontal resistance: A price level where selling pressure has repeatedly stopped advances
- Horizontal support: A price level where buying pressure has repeatedly stopped declines
- Trendlines: Diagonal lines connecting highs or lows
- Chart patterns: Triangles, rectangles, flags, and other consolidation patterns
Key concept: Breakouts work because many traders place orders at these key levels. When price breaks through, it triggers a cascade of orders that can fuel a significant move.
Why Breakouts Create Big Moves
Several factors combine to create momentum during breakouts:
- Stop losses trigger as traders on the wrong side exit
- New traders enter as they see the breakout
- Short sellers cover their positions on upside breakouts
- Long holders panic sell on downside breakouts
- Algorithmic trading systems detect and react to the breakout
Types of Breakouts
1. Range Breakouts
Price breaks out of a horizontal trading range after consolidating between support and resistance.
2. Pattern Breakouts
Price breaks out of chart patterns like triangles, wedges, flags, or head and shoulders formations.
3. Volatility Breakouts
Price breaks out after a period of low volatility, often identified by Bollinger Band squeezes or narrow range bars.
4. News Breakouts
Price gaps beyond a key level due to earnings, news, or other catalysts.
Entry Rules for Breakout Trading
Standard Breakout Entry
- Identify a clear resistance or support level with at least 2-3 touches
- Wait for a candle to close beyond the level (not just pierce it)
- Enter on the close of the breakout candle or on a small pullback
- Confirm with above-average volume (1.5x to 2x normal volume)
Breakout Entry Example
Stock XYZ has tested $50 resistance three times over two weeks. On the fourth approach:
Price: Closes at $50.75 above resistance
Volume: 2.3 million shares vs 1 million average
Entry: Buy at $50.80 after the breakout candle closes
Anticipation Entry (Advanced)
Enter before the breakout with a tight stop:
- Enter when price approaches resistance with strong momentum
- Place stop just below the most recent swing low
- Risk is lower but win rate may also be lower
Exit Rules for Breakout Trading
Stop Loss Placement
- Method 1: Place stop just below the breakout level (now support)
- Method 2: Place stop below the last swing low before the breakout
- Method 3: Use ATR-based stops (1.5-2x ATR below entry)
Profit Targets
- Measured move: Add the height of the consolidation pattern to the breakout point
- Previous highs: Target the next significant resistance level
- Risk multiple: Target 2:1 or 3:1 reward-to-risk ratio
Trailing Stops
After the breakout succeeds, use trailing stops to lock in profits:
- Trail below each new higher low
- Use a moving average as a trailing stop (20 or 50 EMA)
- Use ATR trailing (2x ATR below the high)
Avoiding False Breakouts
False breakouts are the biggest challenge for breakout traders. Here is how to filter them:
Volume Confirmation
- Real breakouts typically have above-average volume
- False breakouts often occur on low volume
- The higher the volume, the more likely the breakout is real
Wait for the Close
- Do not chase intraday spikes above resistance
- Wait for a candle to close beyond the level
- Some traders wait for a second confirming candle
Retest Entry
Wait for price to break out, pull back to retest the breakout level, then enter:
- Reduces false breakout risk
- Provides better risk-reward ratio
- Trade-off: You may miss the fastest breakouts
Retest Entry Example
Stock breaks above $50 resistance on Monday.
Tuesday: Stock pulls back to $50.20 and holds.
Wednesday: Stock bounces off $50 level with bullish candle.
Entry: Buy at $50.50 with stop at $49.50.
Best Conditions for Breakout Trading
- Stocks with clear, well-defined levels
- Patterns that have developed over weeks, not days
- Rising volume as price approaches the breakout level
- Overall market trending in the same direction
- Catalyst present (earnings, news, sector strength)
Breakout Trading Checklist
- Is there a clear resistance or support level?
- Has the level been tested at least 2-3 times?
- Is volume above average on the breakout?
- Did the candle close beyond the level?
- Is the overall market supportive?
- Do I have a clear stop loss and target?
Common Breakout Mistakes
- Chasing breakouts after they have already extended
- Ignoring volume confirmation
- Setting stops too tight and getting shaken out
- Trading against the overall market trend
- Not waiting for candle close confirmation
- Overtrading every small breakout attempt
Track Your Breakout Trades
Pro Trader Dashboard helps you analyze which breakout setups work best for your trading style.
Summary
Breakout trading captures big moves when price breaks through key support or resistance levels. The key to success is confirming breakouts with volume, waiting for candle closes, and managing risk with proper stops. Avoid false breakouts by using retest entries and filtering for quality setups. When combined with good risk management, breakout trading can be a powerful strategy for catching trend-starting moves.
Learn more: support and resistance and volume analysis.