Strategy 1: Breakouts and Volume
Breakout trades are arguably the most recognizable strategy in all of trading. Every retail and professional trader knows from day one how to anticipate them. The strategy is simple.
There are two key components to confirm a breakout: price and volume. Along those lines, when stocks break critical levels without volume, you should consider the breakout suspect and prime for a reversal off the highs/lows.
Breakout Example 1:
The below chart is of Facebook on a 5-minute time interval. You will notice that Facebook was up ~15% throughout the day after a significant gap up. Can you tell me what happened to Netflix after the breakout of the early 2015 swing high?
It just so happens that FB was making a new high on the daily chart, an all-time high to be exact. When you look for stocks that are breaking highs, just look for heavy volume. Volume that exceeds 100% or more of the average volume over the prior 30-90 days would be ideal.
However, a stock making a new a high with 50% or 70% less volume might still work. If we are within the margins, please do not beat yourself up over a few thousand shares.
Breakout Example 2:
In a perfect world, the volume will expand on the breakout and allow you to bag most of the gains on the impulsive move higher. Below is an example of this scenario on an AMD breakout using the 1m chart.
Hopefully this helps visualize what is happening intraday on these breakouts.
Test Example
On that token, let’s test to see if you are picking up the concepts of breakouts/breakdowns with volume. Take a look at the below chart without scrolling too far. Can you predict if the stock will continue in the direction of the trend or reverse?
Come on, don’t cheat!
Ok, now you can look:
The correct answer to the question is this: you really have no idea if the stock will have a valid breakout.
However, from the chart you could see that the stock had nice downward pressure on high volume and only one green candle before the breakdown started taking place. This is where experience and money management comes into play, because you have to take a chance on the trade.
You would have known you were in a winner once you saw the volume pick up on the breakdown as illustrated in the chart and the price action began to break down with ease.
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Quick Summary
This concept of increasing volume on a breakout was also stated in the book Mastering Technical Analysis. In one excerpt, author Alan Northcott discusses how “[Charles] Dow recognized the importance of volume in confirming the strength of a trend. While a secondary indication, if the volume did not increase in the direction of the trend, this was a warning sign that the trend may not be valid.”
As always, if you take a breakout trade, be sure to place your stops slightly below the high to ensure you are not caught in a trap. This strategy works for both long and short positions. The key is looking for the expansion in volume prior to entering the trade.
Keep these in mind:
- The stock has volatile price action with most of the candle color mirroring the direction of the primary trend (i.e. red candles for a breakdown and green candles for a breakout).
- On the breakout, volume should pick up.
- The price action after the breakout should move swiftly in your favor.
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