Trading a breakout is a common strategy, yet buying right at the breakout point is only one way to trade it. There are others. Consider a stock that has been trending higher, and then pauses in a sideways channel. Given the uptrend, a trader could buy near the bottom of the channel, anticipating that eventually the trend will continue and the price will break to the upside. Buying at this level also presents options. If the price moves to the top of the channel, but doesn't breakout (or has a false breakout) the trade can still be exited at the top or middle of the range for a small profit. If the price breaks lower instead, a stop loss is placed just below the channel low and not far from the entry point. Lots of upside, small downside. When possible, this is the ideal play, as it provides a better entry price, more profit potential and a smaller stop loss.
If a breakout occurs before you spot such an opportunity, a breakout can be traded in the traditional manner (trade at the breakout point), but do attempt to minimize risk, as these types of trades are notorious for false breakouts and giving a significant number of losing trades before a big winner is caught.
Opko Health Inc. (OPK) was trading near $8.25 in mid-December and surged to a high of $15.23 by February 25. Since then it has been moving sideways, in a narrowing price range. The rising lows indicate support - and buying zone - between $14.25 and $14.50. A stop loss can be placed below $13.75. Shorter term traders will be looking to exit near $15, near the top of the consolidation. Longer-term traders will be watching for the breakout above $15.23, providing a target of $17.
Stryker Corporation (SYK ) is right near its breakout point of $94.50. This stock rallied more than 25% off the $77.87 October low, to the $98.24 December high, before settling into a descending triangle formation. If the price falls from the current $94.71 level, or slightly higher, there may be another opportunity to buy near support between $91 and $89.81. In that case, place a stop loss below the $89.81 low. If the breakout higher is legitimate, it signals a move to $101 to $103 (based various measurements of the triangle's height added to the breakout price).
SolarCity Corporation (SCTY) has fallen well off the $88.35 high from February 2014, making major lower swing highs along the way. Since May of 2014, support - just above $46 - has held up on multiple tests. For those who believe support will continue to hold, and that the price will eventually break above above the $59.31 high of the current multi-month range, then trading the breakout is one option. Another is to wait for a buying opportunity near support. Based on the height of the current price range, a break higher gives a target of $72. Those bearish on the stock are viewing the resistance area between $58 and $59.50 as a potential shorting region, anticipating a move back to the bottom of the range and possibly a breakout lower. If the price breaks lower the target is $34.
American Airlines Group Inc. (AAL) has been ranging in 2015, following a more than 40% rally between October and January. A sell off in late March pushed the price to the support zone of the range, between $47 and $45.95. On April 20 and 21 the price rallied off support, indicating support has likely held again. Ideally, look for an entry between $50 and $49, with a stop loss below $45.95. $55.50 to $56.20 is a resistance zone, so that is one potential spot to take profits. If the price rallies through $56.20, the target is $65.50 based on the (approximate) height of the range added to the breakout price.
The Bottom Line
Breakouts are notorious for dishing out false breakouts, and frustrating traders with losing trades before the big move eventually comes. Trading at the breakout point isn't the only option though. When an uptrend is present look to buy near the lower portion of a consolidation or chart pattern. If a downtrend is present, look to short near the top of the consolidation or chart pattern. You still may still get stopped out, but the risk is typically smaller than the traditional breakout method, and the reward is much greater. No matter which method is traded, only risk a small percentage of account capital on any single trade.
Cory Mitchell doesn't have interests in any of the stocks mentioned.