Breakout trading explained: patterns and risks

In short

A breakout is a price move through a level where the price previously turned: a resistance above or a support below.
Traders look for a pattern with several touches, a close beyond the level and more volume than usual.
Many breakouts fail. The price then returns into the old range. This is called a false breakout.
A breakout predicts nothing. Use a stop-loss, a fixed position size and account for costs such as spread and slippage.

What is a breakout?

On a chart, a price sometimes stays within a band for a while. The top of that band is a resistance: a level where buyers previously could not push further. The bottom is a support: a level where sellers previously could not push further. The tutorial on support and resistance explains this step by step.

A breakout is the moment the price moves through such a level.

Upward breakout: the price moves up through the resistance. Traders may then consider a buy.
Downward breakout: the price moves down through the support. Traders may then consider a sale or a short. Going short means selling something you do not own, hoping to buy it back cheaper later. This carries extra risks and is not possible with every broker or for every instrument.

The idea behind it: if a level held for a long time and then breaks, the balance between buyers and sellers may have changed. That is an explanation, not a guarantee that the price will follow through.

Common patterns

Traders usually look for breakouts at one of these patterns:

Horizontal band (range): the price moves between a clear support and resistance.
Triangle: the price highs get lower or the lows get higher, so the band narrows.
Flag or pennant: a short pause after a strong move, before the price continues or reverses.
Channel: the price moves between two sloping lines.

A pattern is an interpretation of the chart. Two traders can see different patterns on the same chart. See also the tutorial on candlestick patterns. A fuller description of this approach is on our breakout trading strategy page.

How do traders confirm a breakout?

A breakout is only interesting if there are signs it is serious. Commonly used checks:

Several touches. The level has been tested at least twice without the price going through.
A close beyond the level. The candle closes clearly above or below it, not just with a temporary spike.
More volume. Volume is higher than in the preceding candles. See the tutorial on volume analysis.
The bigger picture. Does the breakout fit the trend on a higher timeframe? See multi-timeframe analysis.
A retest. Some traders wait until the price comes back to the broken level and holds there.

Each check can help filter out false signals, but none rules them out. Waiting for confirmation also means you enter later, at a less favourable price.

Worked example

This example is made up to show the principle. The amounts are not advice.

A share moves between €98.00 and €100.00 for a while. The resistance at €100.00 has been touched three times. On a 15-minute chart a candle closes at €100.30 with more volume than the candles before it. A trader enters at €100.30.

Stop-loss: €99.50, below the upper part of the old range. The risk is €0.80 per share.
Risk amount: with an account of €10,000, the trader chooses a risk of 0.5% per trade, so €50.
Position size: €50 divided by €0.80 is 62.5. Rounded down: 62 shares.
Price target: €101.90. That is twice the risk (€1.60 above the entry).

What happens next is open:

If the price reaches €101.90, the result is about 62 × €1.60 = €99 before costs.
If the price falls back below €99.50, the loss is about 62 × €0.80 = €50 before costs. In a fast price drop the loss can be larger than €50, because the fill can be worse than your stop.

Run your own numbers with the position size calculator and the risk-per-trade tool. More on the relationship between risk and target is in the tutorial on risk and reward.

False breakouts

A false breakout is a breakout that fails: the price briefly goes through the level and then returns into the old band. This happens often. Possible causes are low volume, news that temporarily disturbs the price, and many traders reacting at the same level at once.

You cannot avoid false breakouts. You can limit the loss:

set a stop-loss straight away,
use a position size at which a failed trade barely affects your account,
wait for a close instead of a temporary spike, and know that this worsens your entry price.

Common mistakes

Entering too early, before the candle has closed.
Following every breakout, including those with low volume or an unclear level.
No stop-loss, or a stop you move further away during the trade.
A position that is too large, so that one false breakout costs a large part of your account.
Trading around news. Price moves are then erratic and orders are filled worse.
Chasing a price that has already moved far. Your stop is then far away, so the risk per share is large.

Risk management

Risk per trade. Choose a small percentage of your account in advance. Calculate it with the risk-per-trade tool.
Position size. It follows from the risk amount and the distance to your stop-loss. Use the position size calculator.
Maximum loss per day. If you reach that limit, you stop for the day.
Stop-loss. Set it straight away. It gives no certainty about the execution price in a fast price jump.
Practise first. Test your rules with paper trading or on historical data (backtesting). Include costs in your test.

You can read more about the basics in the tutorial on risk management.

Costs of frequent trading

Breakouts can occur often, especially on short timeframes. Every trade costs money:

Spread: the difference between bid and ask. Around a breakout the spread is often wider.
Commission: what your broker charges per order. See trading costs.
Slippage: the difference between the expected and the actual execution price. In a breakout the price moves fast, so slippage is a real risk, especially with a market order. A limit order limits that, but may go unfilled.

Brokers differ in costs. Compare them based on how many trades you expect to make. You can start with the comparison tool. Treat it as a starting point, not as advice.

Summary

A breakout is a price move through a support or resistance.
Traders look for several touches, a close beyond the level and more volume.
Many breakouts fail. A breakout predicts nothing about what happens next.
Use a stop-loss, a fixed position size and a maximum loss per day.
Spread, commission and slippage cost money on every trade.

This article is educational and not investment advice. Trading involves risk, and you can lose all or part of your money.