Friday, March 23, 2007

Anatomy Of A Stock Breakout

Here's a great example of a breakout trade for a very short-term stock trader. This is the kind of pattern that can work well in trading competitions, such as the one sponsored by CNBC. First, we look for the opening trading range of the first 15-30 minutes. The opening range tells us how market makers are establishing value for the stock (National Semiconductor, NSM; 5 minute bar chart). Note that the opening range (Point A) is above the prior day's close. That tells us that we are seeing increased value being placed in the stock.

At Point B we see a breakout from the opening range on increased volume. That tells us that large market participants are viewing the stock positively, jumping in to buy at new AM highs.

Point C represents the first pullback from the breakout, as some short-term participants take profits. When we see a shallow pullback on reduced volume, as we do here, it tells us that the higher prices are not attracting significant selling. This sets us up for further upside (Point D).

At each pullback in the stock (the horizontal blue lines), we see how far sellers could knock the issue down. Once we get a new move to daily highs, those blue lines can serve as trailing stops to lock in profits.

The nice thing about such setups is that it only takes a few winners to pay for a number of ideas that chop around and don't do much. A majority of profits will come from a handful of nicely trending trades.