95% of my trades are breakout trades and for the last few years, I have tried to refine my analysis to find the right breakouts at the right time.

In this article we will be covering everything about breakouts:

What are they?

Why do I prefer trading breakouts and not pullbacks?

And much more.

So, let's dive deep into it, shall we?

What is a breakout?

A breakout is simply When price breaks an important range or level.

Why do I like Breakouts?

The main reason I prefer trading breakouts is that you know immediately after entering whether you are right or wrong.

In case of pullbacks, the stock may hover around your entry for a long time and then Stop you out of the trade.

Basically, Pullbacks can take more time to show you whether you are right or wrong, but in case of a breakout most of the time if you are wrong your SL will get hit in the next few candles after your entry.

Before knowing how to trade breakouts, we have to know how to prepare a list of stocks that will be more favorable to trade breakouts.

Screening Criteria:

1. Stock should be in the 20% range of its All-time high (52 weeks high only when you become experienced).

Why choose ATH stocks?

Because when a stock is trading at ATH, Every buyer is in profit (greed comes in) pushing the prices higher, the short-covering by sellers work like fuel in flames and push the price even higher.

When a stock is at a 52 week low, almost every buyer is at loss, and every down move creates fear, which creates even more downward moves, every pullback on the upside are sold, so even if you find a good breakout at a 52 week low, the chance of it being successful is very low.

2. Stock should be above 200 DMA. (better if it is also above 50 DMA).

I have written an article on Moving averages, so after reading this one, you can check out that article.

And vice-versa if you are looking to short:

1. Stock should be at a 52 week low.

2. Stock should be below 200 DMA. (better if it is also below 50 DMA).

Now, after you have prepared the list of the stocks fulfilling the above criteria, you have already increased your chances of making money.

Now, it's time to know how to Find and trade breakouts.

Volatility contraction (Tightening Price action)

This is probably the most important concept that you could learn in breakout trading.

What do I mean by volatility contraction?

Volatility contraction is the reduction in the volatility (daily range) of a stock to significant levels, before breaking any important levels.

You might have heard of the VCP pattern from Mark Minervini; that pattern is probably the best way to visualize and understand this concept.

VCP Pattern

This is not a pattern per se but a characteristic of How the price behaves when it is under accumulation while the volatility (daily range) and the volumes dry up before the next big move.

This is how a VCP should look like.

Now, Let's understand the psychology behind this Pattern.

When the First meaningful correction comes during an uptrend, the buyers who bought at the highs are sitting at a loss, and they are waiting for the price to just come back around their break-even so that they can exit without any loss.

Also, Bottom fishers who bought around the lows will also be willing to book minor profit around the Highs.

So, overhead resistance will be created due to the Fear based selling of the Stucked buyers and the profit booking of the bottom fishers.

But, each successive correction will be smaller, as the supply in the market will dry up, and once the overhead resistance is taken out, the demand will precede the supply, thus leading to higher prices.

Also, remember that each correction (time-wise and price-wise) should be 50% less than the previous one and the volumes should also decrease on the down moves.

This is how a VCP looks like on a chart.

Now, many times the price won’t show VCP characteristics, which means the volatility won’t drop much but the price will be stuck inside a range (a box), which we normally call a consolidation.

Let’s know how we can trade these consolidations.

Wait for the Build up

Though the Price is in a big range, and the volatility will be more or less the same at most points, but before breaking out there will be a point where the volatility and the volumes will drop, this should happen around the highs.

It will look like a range inside a range. So it is also a sort of volatility contraction, as I said earlier Volatility contraction is one of the most important concepts and will be used in almost every way we trade breakouts.

The benefit of waiting for a build-up is that you can trade it with a smaller SL, as you get a smaller range inside a big range so you can take the Low of the smaller range as SL.

Plus there is a high chance of a swift move if there is price build-up before the breakout.

Now, there will be stocks that will break the bigger range without showing any build-up (smaller range), so are those breakouts not worth trading?

Yes, they are, but then you have to bear two things, the whipsaws around the resistance level (breakout point) so your SL will be a bit wider, plus the stock can take some time (sideways) to move after the breakout.

So, the priority should be given to breakouts that show Price build-up, but just know that the other one is also tradable just you have to change some tactics.

Inside Bars

Inside bars are also another way of trading Volatility contraction, as we look for the volatility drop from wide bars to extremely narrow bars.

Inside bars can form on any Time frame, though the higher the time frame, the better it will work.

But, it's not like wherever an inside bar appears you should jump on and take a trade, NO!

The location of where an inside bar form is way more important than you think.

The first thing you should keep in mind is that the major trend should be up, the stock should show signs of underlying bullish current.

If the stock is in a downtrend the Inside bar breakout will fizzle out, and then you will say that IB doesn't work.

Let’s take an example of how we can use Inside bars.

Below is the weekly chart of Lupin, The stock was in a major consolidation for 7 months.

The volatility and the volumes kept reducing, and the stock formed a weekly inside bar, with a high of 1083 and a low of 1045.

The high of the bigger range was 1122, so the majority of the breakout traders would have entered above that level, but as we got an inside bar before the breakout, we will use the high of this candle as the entry point.

And the stock just soared after the breakout.

Rejection Breakouts

There will be many instances where a breakout will fail, and the breakout candle will close below the breakout point.

And this could potentially be a sign of reversal, but but but, If that Rejection High is again taken out by bulls, then it's a wonderful opportunity to enter the stock.

And because this will be the second attempt to break out, it will be even more powerful.

Let’s take a very recent example of Rejection breakout to understand it better.

Below is the daily chart of HAL, it was in a range for a month, and then gave a breakout, but that breakout didn’t sustain.

And the stock retraced back to the consolidation zone, but it didn’t give any follow-through selling.

After 2 days, it again broke above the consolidation zone, and this time our buy point trigger was the high of the rejection (Failed breakout) candle.

After that, the stock gave a good follow-through move.

Shakeouts

A shakeout is when price undercuts a major swing pivot, but retraces back quickly.

The name shakeout is due to the fact most weak hands won’t be able to hold the stock after the steep decline in price, and their SL’s will be taken out.

Once the Weak hands are out of the game, the stock regains the previous levels.

Breakouts that happen after shakeouts are much stronger than the Normal breakouts.

Let’s take an example for this one too.

Laxmi Organic is one of the favorite stocks of Positional traders as the stock has given a fabulous run in the past few days.

In the below chart you can see that the stock was in range, but a big candle broke below the low of the range but gave a close inside the range.

That was a shakeout candle, taking SL’s of weak hands.

Then for the next few days, the volatility reduced and stock made a pivot point.

And after almost a week the stock gave a breakout and a fabulous run.

Shakeouts can be used on any time frame, daily, weekly, or even smaller time frames like hourly.

Also, remember that sometimes the shakeout candle will close below the lower range, but the next candle will again come back in the range, it will also be considered as a shakeout.

Deciphering Volumes

Volumes play a very important role, before, during, and after a breakout.

Most of the time before an ideal breakout, the volumes will dry up, which is the sign of drying supply.

At the time of breakout, higher than average volumes are signs of a good breakout.

But remember if the Breakout candle is showing big wick, and higher than average volumes, in which the body of the candle is less than 60% of the candle size, then that might be a sign of weakness, as the stock is showing signs of supply just after a breakout.

After a successful breakout, we should see higher volumes on the green days and lower volumes on the down days.

A down move with low volumes, is just a breather, a normal reaction which a stock does after the breakout.

Powerplay setup

This is a different Breakout play than the previous ones, as in this we do not use the concept of Contracting volatility, this is rather a setup in which the stock is in a hurry to go up.

Once the institutions are in a hurry to buy a stock, the stock might not give proper consolidation setups.

This kind of buying will come, when the stock is at ATH, breaking Multi-year Highs.

The prerequisite for this setup is that the stock should have seen some serious buying in the last 4-6 weeks, i.e up more than 50%.

Now, let’s combine whatever we have learned in this article by looking at one more trade example.

Trade Example

Below is the chart of Divis lab, The stock was moving sideways in a range of 3900 to 3300.

Then a shakeout comes breaking the lower range and weak hands are out of the stock, stock jumps back in the range the very next day, which is a bullish sign.

Now, at this point, it could be an aggressive entry, so either one could have entered here or waited for a pivot point to form for a low-risk entry point.

And after almost a week we get a pivot point around 3550, above which we could buy.

After that, the stock again tested the high of the range and formed a consolidation pattern (build up), which was also an inside bar on a weekly chart.

So, this could have been the second opportunity or pyramiding opportunity for the buyers.

After that, the stock gave a breakout and gave an amazing move.

Final Thoughts

Most traders focus upon learning the patterns, i.e cup and handle, flag, pennant, triangle but they never try to understand why they are working, they never try to look for the fundamental characteristics of those patterns.

My suggestion to you will be that you should try to understand why something is working rather than just accepting that it works, whether it is patterns or something else.

And you shall become a profitable trader.

So, that’s it for today from our side, we will meet you next week, till then don’t forget to share this article with your friends over social media.

Thanks for reading.