From the May 2013 issue of Futures Magazine • Subscribe!

Everything you know about breakout trading is wrong

Signs of success

One of the first things to consider in a trading channel breakout is the momentum, or pace, of the price moves within the channel itself. A trading channel is essentially a series of smaller trend moves whereby the price of the security bounces between support and resistance levels (the lower and upper ends of the channel). How the momentum of these moves shifts within the channel is a good indication not only of the direction of the breakout, but also whether a breakout is sustainable.

When the momentum of upward moves within a trading range is slower than the downside moves, then the probability of a break lower increases. In the breakdown in “Flushed out,” the situation was reversed. The upside moves within the channel were stronger than the downside moves prior to the first breakdown attempt. This is indicated by the steeper angle of the moves from “A” and “C” in “Momentum setup” (below).

It was not until after the first breakdown and upside flush that momentum shifted. The two-wave correction following the first breakdown attempt began with the strong flush higher off the lows from “D” to “1,” but as E-mini Dow futures went for the second high from “E” to “2,” this momentum changed. The buying slowed compared to the selling, and it took nearly twice as long for the Dow to recoup losses off the high marked as “1” than it did to return to the zone of that high at “2.” The breakdown coming off that second high following the failed breakdown earlier in the morning had a better chance for success.

Another notable difference between this second setup and the first breakout was the entry trigger. In “Momentum setup,” the smaller channel break from the slower upswing within the channel provided the entry trigger as opposed to a break in the lower extreme of the entire channel.

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