Chart Breakouts

What is a breakout?

At any one point in time it is normal for the stock market participants who have an interest in a stock to have their own opinions about the “fair value” of the stock, and these opinions of price will fall into a range in share price. The participants rarely agree on just one price. Depending on the particular stock, and on many factors such as the latest news and announcements, this price range could be a small range, or it could be large. 

Over time, the range in price can often be enclosed on the price chart within a series of straight lines, which often form either a chart pattern, or it could be a horizontal line of resistance. Another range-bound observation can be when a trending price moves up and down within a trend channel - with a pair of sloping parallel lines that contain the price action (in both an uptrend and a downtrend).

At some stage, if all of the interested sellers of the stock have finished selling, and if only buyers are left, then the share price will move higher. And conversely, if all the buyers have finished buying, then the share price will move lower. And it is possible that news or announcements can precipitate a move in share price.

The so-called breakout occurs when the price suddenly moves outside of it's recent trading range.

Three common breakout types

Three common types of chart breakouts are:

• The breakout that follows a period of price consolidation.
• The breakout that follows a period of narrowing price variation within a
  chart pattern like a Symmetrical Triangle. 
• The breakout from within a rising (or falling) trend channel.

Price breakouts occur because of the opinions of “fair value” of the market participants (ie. the buyers and sellers in the market). These breakout situations are best explained by examples. Following is one example, and more are included in both the ASX Investor Update material, and in the Toolbox eBook Articles (see list at right).

Example - Lynas Corporation (LYC)

During the months of February to May 2010, Lynas Corporation traded mostly within a narrow range between 45 cents and about 56 cents. To see the actual range in price each day we need to look at the accompanying candlestick chart which covers the period from late March to mid-July (click on the chart image at right to see a larger version). Towards the right-hand end of this chart we can see that the price has broken above the trading range. It actually went on to rise about 360% over the following 44 weeks. If only we all could have spotted this at the time.

In this price chart note that the price rose in April to about 57 cents — the solid red line on the chart indicates this price level as an approximate zone of resistance. In May, the price fell to within about 45 to 47 cents on two occasions, except for the single spike low on 5 May. The green line at 45 cents indicates the bottom of a zone of likely price support. Throughout May the price tried to rise above about 54 cents on two occasions, but retreated both times.

When the price fluctuates in this manner between an upper and lower price, it suggests that the buyers and sellers have been in some disagreement about the actual value of the shares. When the price rises to a level that is perceived to be too high, sellers take profits and overwhelm the market participants resulting in the price falling. But when the price falls too far, the buyers step in and overwhelm the sellers, out bidding each other and forcing the price higher.

In this case, in late June there must have been a change in opinions because there are three consecutive white candles on 16-18 June pushing above the recent resistance of about 54 cents, followed by four days where three of the candles have no candle body (these are called doji candles and indicate indecision about whether the price should rise or fall). Then a Big White bullish candle (with no tails) on 25 June accompanied by higher volume — relatively higher than in recent days. Price then fell back to the old resistance level of about 54 cents, which has now become a support level to hold the prices up. After several days the price moved higher on 9 July and on much higher volume which indicates a strong level of support from buyers to out-bid each other higher. The rest is history (up 360% in 44 weeks).

More details...

More Information

• ST-6130 "Breakouts - Introduction"

• TA-3900 "Breakouts - Case Study samples"

• BC-26-500 "Breakout Tools in BullCharts"
  

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© Copyright 2012-2013, R.B.Brain - Consulting (ABN: 52 791 744 975).
Last revised: 19 March, 2013.