From the May 2013 issue of Futures Magazine • Subscribe!

Everything you know about breakout trading is wrong

Because the early breakdown in “Flushed out” was followed by a two-wave correction back into the channel and because the second wave of that correction was slower than the first, the odds of a successful trade dramatically improved; thus, the need for a wider confirmation of a channel break diminished. The channel was now ripe for a breakdown, even though the prior low had not yet been tested, let alone broken. In fact, waiting for that break to occur would have increased the risk of failure because much of the trade’s potential would have been spent when the trigger occurred.

Another factor that bolstered the second setup was the amount of time it took for the trading channel to form prior to each breakdown attempt. Corrections within a security tend to last for comparable periods of time when the moves leading into the channels are similar. So, when trying to determine if a trade may be too early or whether an ideal amount of time may have passed, study previous corrective moves.

“Timing is everything” (below) depicts a similar period of price congestion on the same time frame two days earlier than the breakdown we’ve been studying (although the strategy was slightly different because of a wider trading range). When the Dow congested on the left side of “Timing is everything” at “A,” it was faced with a premature breakdown attempt also.

In terms of time development, the amount of time the Dow had corrected off lows prior to the attempted breakdown was similar to the level where it tried to break lower in “B.” This is shown in the blue rectangle. It was not until later that a larger decline began in the “A” congestion. This indicated a risk that the first breakdown attempt in “B” could also be a false start. Once this second period of congestion lasted as long as the prior one, however, the true breakdown began. For even greater clarity, go back further in time to locate additional channels for comparison.

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