How To Recognize a Breakout

One of the easiest ways to learn how to recognize a breakout is to look at past examples and look for conditions that existed prior to the breakout, and also existed in different examples.

In other words, find "common" conditions that existed on more than one occasion that were followed by the same result, in this case, a breakout.

Today's article topic came to me while I was looking at a chart of Silver, which hit new highs once again as I am writing.

Since most of the site readers here at Online Stock Trading Guide trade Stocks and Options including myself, I'll be using SLV below. SLV is the ticker symbol for the iShares Silver Trust ETF which trades daily like a stock and had 13.56 billion dollars in assets as of March 31, 2011 according to Yahoo Finance.

I'm not going to show common conditions on various charts in this article as I am relying on my previous experience and knowledge of how to recognize a breakout to pass along here. If you were to do research for yourself, on your own, you could print out charts that display breakout stocks and look for the common conditions yourself.

There also are various ways to look for breakout stocks and we'll cover some of those in another article but for today, take a look at the beautiful breakout for swing traders that occurred back around early September, 2010 on the chart of SLV below:

How to recognize a breakout

The chart above really is a beautiful example to help learn how to recognize a breakout. Let's take a closer look:

Back in July, 2008, a top was made (on this chart) and then prices declined along with the rest of the markets into November, 2008. SLV and other markets including most equity markets rose into the start of 2009, but the major equity markets declined again and made new lows on March 9, 2009 (not shown), yet SLV did not (another signal for another article).

Between November/December 2009 and July, 2010, prices rose to the previous high made in July, 2008 several times, but pulled back as this previous high acted as upper resistance.

In September, 2010, prices once again moved up to the previous highs, only this time a breakout occurred!. This new breakout occurred up through a multi-year high.

In addition to the clear breakout signal to new highs, take a look at what happened over the almost 2 year time period since the November, 2008 lows: lows were made in the uptrend but almost all of the new lows were higher than the previous new lows in the uptrend from November, 2008. These rising highs bouncing off the upper previous resistance along with rising new lows formed an Ascending Triangle.

So, in our example of how to recognize a breakout we had a clear move up through to new highs as one obvious signal for momentum traders to buy if they hadn't already along with a clear Ascending Triangle - which is bullish in most cases. These two conditions combined produced an accurate buy signal for swing traders for Stocks or Options, taking the usual precautions by implementing stop loss mechanisms for each position.

For some additional support of our thoughts on the breakout, we can look at a longer time period chart. Take a look at the next chart below and see the additional confirmation that occurred:

How to recognize a breakout - 5 year chart

Before I end this article, I want to briefly go over what was happening as the Ascending Triangle was forming: as each high was made and attempted to break through the previous high set back in July, 2008, traders and investors started selling and taking profits. As prices then declined from the selling, new buyers stepped in and helped cause prices to rise again. With each decline you'll notice there were higher lows made - this was from the number of sellers willing to sell their shares decreasing each time, and new buyers coming in more and more. Finally, towards the end of the Ascending Triangle, there were no more people willing to sell, only more buyers willing to buy. When the buyers out-numbered the sellers just prior to the breakout, the breakout to new highs occurred. (Some generalization here to explain the concept).

So there you have it - a beautiful, clear example of how to recognize a breakout. You can check stocks making new highs for similar patterns and do some testing on your own now. Keep in mind there are different ways to look for stocks breaking out and for different trading styles, this is only one example, but it is a simple, easy method that can be learned, replicated and put to use.

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