Tuesday, February 12, 2013

The stronger the breakout...

More often than not, the stocks which generate the biggest trends will breakout into a new trend following a period of consolidation, and will not look back. Occasionally price will fall back to the original breakout level before moving in the direction of the new trend.

In his Market Wizards interview, David Ryan (a disciple of William O'Neill) talked about this, and how that, if a stock broke out but then subsequently fell back into the consolidation area, then he would cut his position 'at least by half' as the odds of a successful breakout and trend were now greatly diminished. If you choose to use a trend following methodology using Donchian style price channels (such as I do) then it is easy to identify these levels, and to determine whether a meaningful trend (and therefore a profit) is likely to develop.

Remember that we are playing the odds, and that like all things trading there are exceptions to the rule. All we are trying to do is balance the odds in our favour. Given the choice between a stock that exhibits a violent breakout in short order, or one where price meanders above and below the ideal entry level (or worse, tries to breakout and fail, before drifting off in the opposite direction), should be a no-brainer.

As an example, if you look through a sample of charts of the best performing stocks in the last few months, then the vast majority will show a strong breakout, with that initial price level not being breached once broken. If desired this also gives you the opportunity to minimise your open risk, as such a move would allow you to move your initial stop to the entry (breakeven) level almost straight away. Then it is simply a question of riding that trend, and using a trailing stop per your system rules.

Here are a couple of UK stocks in the last few days that the people in the mentoring programme were aware of and have traded, which exhibited this characteristic.

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