How to Position Yourself for a Stock Breakout

November 7, 2016

The idea that drawing lines on a chart can lead to incredible profits has been a matter of contention for years…

Warren Buffett, Peter Lynch, and Benjamin Graham for example aren’t exactly fans of the idea.

Even in a world of charts, trend lines, and candlesticks, they have relied entirely on fundamental analysis to earn their famous fortunes.

In fact, their disdain of technical analysis is so complete that Buffett once remarked, "I realized technical analysis didn't work when I turned the charts upside down and didn't get a different answer."  Meanwhile, Lynch observed, "Charts are great for predicting the past."

Graham before them famously said, "In the short term the market is a voting machine, but in the long run it is a weighing machine."

Instead of focusing on solely on market momentum, all three simply focused on finding long-term value.  And over time, it made all of them very wealthy.

But the fact remains that technical analysis works… and works well.

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And the key to its effectiveness lies entirely in its popularity among large audiences.

For example, if you’re familiar with the term technical analysis, chances are you’ve also heard the term “breakout.”  In short, it refers to buying stocks as they just begin to “break out” above prior resistance levels or “break down” below prior support levels. 

Trading breakouts isn’t anything new. 

It’s been mastered by trading great such as Nicolas Darvas and Stan Weinstein – who know very well that once a stock begins to break above prior resistance points, the stock has the potential to trend even higher… and that once thousands of traders learn about it, they pour in, too.

The key to trading a breakout successfully is being early.

You see if support and resistance serve as current barriers to price movement, a breach or previous support or resistance could be a precursor to a bigger move.

Think of it like this:

When you’re stopped at a stoplight, you don’t try to predict when the light will go green. 

Instead, you just hit the gas and hightail it out of there when it does. 

The same approach happens with a stock.  Once it breaks above prior resistance points, we don’t wait… we buy, hoping the breakout lasts.  We’re simply for stocks where share prices have moved above prior price barriers created by incredible support and resistance points.

A perfect example is the Dow Transports.

It’s a great visual of the stoplight phenomenon. 

The chart continued to stop the stock at overhead resistance since March 2016.  Once the index broke above such heavy resistance, the stoplight turned green… and the index ran.

The key to buying wasn’t predicting the breakout – it was buying the actual resistance break.

One of the best ways to find potential breakout stocks is to gather a few dozen names that have been trading in a tight channel, where support and resistance are easily definable and have been long-lasting.  Once you find ones that meet such criteria, keep them on radar.

Once the green light is signaled, try to be on top of it immediately.

One stock to keep on radar for example could be Visa (V:NYSE).

If you take a look at this chart of Visa, you’ll notice the stock has been in an uptrend for weeks, but recently stalling at heavy resistance at $84 a share. 

Every time the stock swings lower and retests the $84 high, it fails. 

Traders should now look for a potential breakout if on the latest test it manages to break above $84.  If and when that happens, the stock could reach a new all-time high and trend higher.

I hate saying it, but a big reason most breakout trades fail is because buyers can be lazy. They don’t want to do the research or be patient, or even take the time to build a watch list.

They want some one to tell them what to do.  The problem with waiting for some one else to tell you that a stock broke out – you’re already too late to the party.

If you want to successfully trade breakouts, here’s the best advice I can share with you:

Do your homework and the research.  Plan ahead and have the discipline to follow through according to the trade plan.

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