Updated: Apr 21
"An object will continue to be in the state of rest or in a state of motion unless an external force acts on it"
This is the Law of Inertia discovered by Sir Issac Newton. One of the phenomenal discoveries that have laid the foundation of modern science. The law of inertia not only applies to the physical world but also to the realm of the Stock Market.
As you are aware that the market has two major stages which are:
The market which is trading will tend to be in the trading range unless and until there has been a breakout due to mass buying or selling of the stock. Eventually, the stock will gain momentum either in an upward or downward direction.
The trading range can be described as the prices moving inside a consolidated horizontal zone touching its boundaries. Its price action would represent a whipsaw movement.
Scalpers can take advantage of this zone. It is an easy trading zone where one can buy at support and sell at resistance. We will cover it in a separate blog.
To make huge profits, one has to place their trades in the direction of a trend. The transition between the trading zone and the trending market is called the breakout.
By meaning breakout, it also has a possibility of being a 'fakeout'. One should consider this to avoid potential losses.
These are the aspects that one should look for the breakout to happen:
Build Up at Resistance
The consolidation market is a tight trading-ranged market where the prices hit and bounce inside support and resistance.
It can be a perfect horizontal trading range or a flag or a wedgie. The important aspect to identify is that it is not trending and has tight price movements.
The tighter the consolidation higher the possibility of the breakout.
(The prices are moving in a range where the price actions seem like a whipsaw movement. The prices are contained inside the range because of Inertia or its inability to escape its range.)
BUILD UP at Resistance:
After moving back and forth inside the trading range, the price will accumulate either at resistance or at support before a breakout.
The accumulation of the prices at resistance would mean a bullish breakout. Whereas the build-up of the price at support would indicate a bearish breakout.
This phenomenon occurs because of the inability of the price to be contained inside the trading range as before. It indicates that one party is gaining control over the other.
(As you can see the prices are accumulated on the resistance and fail to follow the ranged markets' movements. A solid signal for a breakout)
10 MA's Support:
When the prices build up at the resistance the 10 Moving average should come near the bottom of the price accumulated and provide support.
In most cases, the prices which have moved far away from the moving averages fall down to receive its support. If that fails to happen it indicates that there is some other strong support being provided.
This gives us prior signals for a breakout.
(After the prices have built up or accumulated near the resistance and its failure to fall back the moving averages come onto the top to provide additional support.)
After reading those prior topics, you may have a rough assumption of when to enter the trade. If not, think about it and read the latter after that.
Have you got it? Yes, once it has broken the range inside which it has been contained in before.
But what if it is a fakeout? A fakeout is a temporary or failed breach over the range only to fall inside it. No one wants to enter a trade with the possibility that it can be a fake-out.
So, what can we do? We can wait for the retest of prices to occur. A retest is nothing but the prices retesting the level of support or resistance. Once it has broken the resistance, it should be converted into support.
(The price broke above the resistance and pulls back a little to retest the zone of support (previous resistance) only to bounce back higher)
In most cases, the price tends to retest the support level (previous resistance). Once the restest has been done and the price can no longer fall below the support level followed by rejection candles one can enter the trade without fear of a fakeout.
But being this conservative can cost you losing a successful breakout trade. Because in few cases the prices don't tend to retest the new support levels. Instead, they just move in fast in a certain direction until it is too late to realize there will be no retesting.
If you are willing to take the trade without waiting for the retest, have a slightly tighter stop loss.
Identify whether the market is in a trending or trading range.
Look for consolidation of the market, building up of prices, and support or resistance from 10 MA's which are signals of possible breakout.
Wait for the retest of the prices or follow strict stop loss.
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