Shares digital

Price breakouts occur when price action signals a radical change in trend. Obviously, over time, prices can trend up, down or stagnate oscillating sideways. The first two phases can be relatively easy to trade with a trend-following study such as moving averages, trendlines or trailing stops. But often markets congest in short-lived up and down moves that whipsaw any trend-following measure into oblivion resulting in losses for the trader. Such periods can lead to the rejection of techniques that work well at other times. This demands a method to signal when a stock is moving from one phase to another. Here breakouts can come into their own.

Even in a phase bereft of trend it is possible to define the boundary markers beyond which a reassessment of market phase would be called for.

Many professional traders find sideways-ranging markets lucrative opportunities, always being aware when the fun will end and a new trend begin. The key is to be able to recognise quickly when a phase shift has occurred. Many traders will probably be watching for a move above or below a significant level and such a move will be accompanied by a rise in volume as the early birds get into the new move. So a break of a significant level, preferably by a decent margin and on a close basis, accompanied by raised volume is as sure a sign as you’ll get on a chart that something’s afoot. Some software (Sharescope for example) can be used to screen for jumps in volume (volume to moving average of volume difference) and, say, new price highs or lows over a given period, thereby isolating possible candidate stocks for closer examination.

Also, because such events are so important, various indicators have been developed to help. Perhaps the best known of these is Welles Wilder’s DMI system, which provides separate measures of bullish and bearish strength and of general trending based on the propensity of price to break above or below a trailing time window of bars that define an upper and lower range. This idea of a box on the chart, breakouts from which define the start of a new trend, was successfully used by Nicolas Darvas, who famously traded an initial $36,000 up to more than $2.25 million in three years during the 1950s using his box breakout technique. A simple system based on breakouts from a 10% range box that needed to form over a three-week period.