Breakout Trader

DEFINITION of 'Breakout Trader'

A breakout trader is a type of trader who uses technical analysis to identify high conviction breakout patterns that can profit on bullish rallies or bearish downtrends.

BREAKING DOWN 'Breakout Trader'

Breakout traders primarily follow technical charts to identify breakout price patterns as these patterns have high potential for showing short, intermediate and long-term trends.

Spotting Breakout Patterns

Generally, the most popular breakout patterns occur at resistance and support levels in a Bollinger Band envelope channel. Other envelope channels may also be used such as Donchian or Keltner. Additionally, some traders may rely on other special patterns such as ascending triangles, descending triangles or head and shoulders.

Bollinger Bands chart upper and lower trendlines two standard deviations above and below a moving average midpoint. These trendlines, similar to other envelope channels, create a reliable trading range for which a security pattern will typically follow excluding any major unanticipated news announcements. The resistance and support lines in a Bollinger Band channel are critical for a breakout trader as they chart levels at which a security is highly likely to show a reversal followed by a breakout.

A second price pattern that can be used to identify a breakout is a wedge channel. Both ascending and descending wedge channels are formed from non-parallel lines that point to price points where there is a high chance for a reversal. Ascending wedges will be drawn with two positive sloping lines ending in a wedge. Adversely the descending wedge is drawn from two negative sloping trendlines. In both channels, trendlines are drawn above and below peak and trough price levels.

Traders can use both wedge channels and envelope channels together to help confirm a breakout price point. A potential breakout is also usually confirmed first by a breakaway gap. In a bullish breakaway gap this pattern occurs with two consecutive white candlesticks where the second candlestick open is substantially higher than the previous day’s close. Adversely in bearish breakaway gaps the pattern includes two consecutive red candlesticks with the second day’s open at a price significantly lower than the previous day’s close.

Trading Strategies

Traders spotting a potential breakout can implement a grid trading strategy that automates buys and sells at pip intervals. This grid trading strategy can be beneficial since most breakout traders will seek to trade the bullish or bearish price trend which occurs through a cycle that usually includes a breakaway gap, several runaway gaps and an exhaustion gap. For less complex trading strategies, breakout traders can also use standard buy and call option orders at the support level. Adversely, sell and put option orders are typically used at the resistance level. If a trader sees supporting indicators or fundamental indicators leading to a breakout above or below the resistance or support lines they may also initiate breakout trades at these levels.