- October 25, 2011
When to Buy and When to Ignore Stock Breakouts
by Donald Harder
Trading stock price breakouts can be one of the most thrilling or frustrating endeavors in a stock trader’s career. When they work, they work well and can lead to significant profits. In a strong bull market you can pretty much throw a dart at the wall and pick stock profitable breakouts. However, when the market is in a choppy faze, typically what happens is breakouts will fail, causing traders to stop out.
Adding insult to injury, when the market’s trend finally resumes, traders have lost so much money chasing failed breakouts that they fail to pull the trigger and sit on the sidelines as prices run away from them.
Measuring the Market
Measuring a stock’s volume can only take you so far. If stocks do not have a tail wind in the form of a strong market, breakouts are more apt to fail even if volume behind the move is solid. Fortunately, there is a relatively simple way to measure the strength of the market.
In early October of 2011, the stock market was at the brink of disaster. The headlines in the financial journals focused the market’s attention on the European debt crisis and the market had made a new low on the year, which you can see in the Dow Transport index to the left of the screen.
But then something interesting happened.
The Dow transports and the financial sector rallied off their lows and marched higher over the following weeks.
Keep in mind market sentiment was at multi year lows and arguably two of the weakest sectors in the market were transports and financials.
Look at the Weakest Sectors
So, what is the lesson here? When the market should be going down, yet its weakest sectors are rallying it is reasonable to conclude that the market is climbing a wall of worry. Does this mean you want to trade transport or financial stocks?
Probably not. What we see here is a market that is rising and pulling up the weaker sectors. This in turn gives the signal to start looking for breakout plays in the leading sectors.
Resources
Market Zeitgeist: SPX Succumbs to Breakout Failure
Solas Trader: Solas Trend Finder Takes Bullish Outlook in Financial Sector
Contrary Investing: A Short Term Buy Signal for Financial Sector ETF XLF?
The Stock Sage: The Secret of Breakdowns/Breakouts: Volume
3 Comments
going to be ieinresttng with the news on Sunday out of Europe.Nice channel btw, keep them coming!
Looks like we will have a weekly bk on SPY. The market appears to be paying more attention to US employment than Europe right now. At least in recent weeks, Europe has been on ignore. As long as their is nothing overtly negative from Europe on Monday, we could see a tradeable breakout event. I’m inclined to protect profits here as opposed to adding too much fresh exposure though. These types of breakouts need to prove themselves and it’s easier to re add longs than it is to hold and hope the breakout sees follow through.
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