Setting Stop Losses in a Breakout Strategy

Using breakout strategies in your trading can help to easily identify trading opportunities as they occur. When these situations develop, we can see where the entry levels can be placed, but what about the other side of the equation? How do we know how to close out the trade once it has been opened?

“One of the first things that new traders should learn is that no trade should be opened without using a protective stop loss,” said Haris Constantinou, currency analyst at TeleTrade . But looking for stop loss levels in a breakout strategy can be a difficult factor to implement. Since common trading rules have established that a successful breakout trade should be followed by a surge in volatility (in the direction of the break) there is a decreased probability that prices will see a quick reversal. If this does occur, however, it should be viewed as a major red flag and indicative of the fact that a false break might be in the works.

Hypothetical Examples

For example, if an upside break of resistance is seen (and a buy position is established) stop losses should be placed below the previous low (the support low that occurred before the breakout was seen). This is based on the assumption that any downside violation of support would suggest that any momentum in the upward resistance break has reached completion and that prices are likely to extend lower. In these cases, it is best to just cut your losses and exit the trade.

In the reverse scenario, if a downside break of support is seen (and a sell position is established), stop losses should be placed above the previous high (the resistance high that occurred before the breakout was seen). This is based on the assumption that any upside violation of resistance would suggest that any momentum in the downward support break has reached completion and that prices are likely to extend extend. In these cases, it is best to just cut your losses and exit the trade.

Gaining the Advantages of Breakouts

With all of these factors taken into consideration, breakout strategies can be used to beat market participants in terms of long term profits and losses. You will be looking for critical breaks of support or resistance levels as an indication that market sentiment is changing and that previous pricing valuations are no longer appropriate. There are some risks with these strategies, as there is always the possibility that you will encounter a false break and this is the reason protective stop losses must always be used.

But given the additional confirmation strategies that can be used (such as a confirming indicator reading), traders using a breakout strategy will be able to turn the odds in their favor and use money management strategies to maximize gains and limit losses. Over the longer term, breakout strategies can be a highly effective way of identifying solid trading entries that are easy to visualize on your trading charts. But it is always important to have safeguard stop losses in place before these trades are initiated.

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