How to Trade Breakouts

How to Trade Breakouts Using Trend Lines, Channels and Triangles.

Trend Lines

The first way to spot a possible breakout is to draw trend lines on a chart. To draw a trend line, you simply look at a chart and draw a line that goes with the current trend. When drawing trend lines it is best if you can connect at least two tops or bottoms together. The more tops or bottoms that connect, the stronger the trend line.

So how can you use trend lines to your advantage? When the price approaches your trend line, only two things can happen. The price could bounce off the trend line and continue the trend. The price could break out through the trend line and cause a reversal.

We want to take advantage of that breakout!

Channels

Another way to spot breakout opportunities is to draw trend channels. Drawing trend channels are almost the same as drawing trend lines except that after you draw a trend line you have to add the other side. Channels are useful because you can spot breakouts in either direction of the trend.

Plotting a channel is very simple, if you know how to draft a trend line, something which we have already explained in the article “The Trend – a Traders Best Friend”. Once you have successfully placed your trend line, you need to draw a parallel line with relatively the same length and tipped at the same angle as the trend line, and project it into the future.

As you already know, uptrend lines should be plotted between support troughs, which means that when the market is trending up, the trend line lies below the price action. Logically, downtrend lines should be plotted between resistance peaks, meaning that when the market is trending down, the trend line appears above the price action.

Triangles

The third way you can spot breakout opportunities is by looking for triangles. Triangles are formed when the market price starts off volatile and begins to consolidate into a tight range. Our goal is to position ourselves when the market consolidates so that we can capture a move when a breakout occurs.

There are 3 types of triangles:

1.Ascending triangle

Ascending triangles form when there is a resistance level and the market price continues to make higher lows. This is a sign that the bulls are slowly starting to gain momentum over the bears. What we are looking for is a breakout to the upside since ascending triangles are generally bullish signals. When we see a breach of the resistance level the proper decision would be to go long.

2.Descending triangle

Descending triangles are basically the opposite of ascending triangles. Sellers are continuing to put pressure on the buyers, and as a result, we start to see lower highs met by a strong support level. Descending triangles are generally bearish signals. To take advantage of this, our goal is to position ourselves to go short if the price should breakout below the support level.

3.Symmetrical triangle

The third type of triangle is the symmetrical triangle. Rather than having a horizontal support or resistance level, both the bulls and the bears create higher lows and lower highs and form an apex somewhere in the middle. Unlike the ascending and descending triangles which are generally bullish and bearish signals, symmetrical triangles have NO directional bias. You must be ready to trade a breakout on either side!