A breakout is when the price of a financial instrument or asset trades below a level of support or above a level of resistance. Breakouts demonstrate the possibility but not a certainty for the price of the asset or instrument to start a new movement in the direction of the breakout. As an example, a breakout through a major support level to the downside could indicate that the price will start to trend lower. Breakouts that occur along with high traded volumes (relative to normal traded volumes) confirm greater conviction and a greater likelihood that prices will trend in the direction of the breakout.
Breakouts will occur when a price has been contained, often for long periods, above a major support level or below a major resistance level. This level will become a line in the sand for breakout traders to enter the market once the level is broken or for traders already holding positions, who didn’t want the price to breakout, will have stop losses triggered and avoid larger losses.
The large increase in trading activity at the breakout level will more than likely cause an increase in volume traded. The higher traded volume will help to confirm the breakout. However, if volume does not increase around the breakout, it may not be confirmed and could likely fail.
Key takeaways:
- Breakouts are used by breakout traders to enter new trades at key support and resistance levels.
- Price will normally retrace to a breakout level due to profit-taking by short-term traders.
- Breakouts resulting in higher volume usually have more conviction.