Breakout

Quick definition

A breakout occurs when a stock’s price passes a point of resistance. 

Key details

• A breakout occurs when a stock’s price passes a point of resistance. 
• It’s a sign that sellers are unloading shares around that point.
• For a stock to break out, its volume must soar at least 40%-50% above its average daily output.

What Is a Breakout?

A breakout occurs when a stock’s price passes a point of resistance. That point of resistance can come at many different points; wherever it occurs, it’s a sign that sellers are unloading shares around that point.

A breakout thus signals that the stock has far more buying power behind it this time, enough to overcome sellers and the resistance they’re previously offered. The stock then shoots higher in heavy volume, launching a new uptrend. 

How a breakout indicates strength

It starts with historical precedent. The stock market as a whole as well as individual stocks repeat the same patterns and behaviours, whether we’re in the 1920s or the 2020s.

Look at some of the biggest stock winners of all time — everything from U.S. Steel to IBM to Tesla — and you’ll find huge breakouts propelling those stocks higher. 

For a stock to break out, its volume must soar at least 40%-50% above its average daily output.

Thus by definition, it’s a powerful indicator of strength: Stocks that clear key resistance points in heavy volume are being bought by the big mutual funds and other institutional investors that (with apologies to your auntie and her $500 investment) make the market go.

Breakout points and buying opportunities

Buy low, sell high. That’s the common mantra of stock market investing. But that’s easier said than done. Trying to buy a stock on the way down can be like trying to catch a falling knife: You could end up with blood everywhere. 

The theory behind buying at breakouts is that the downward forces that can hold down stocks’ success have departed, clearing the way for a burst of buying by big-money investors.

It’s not that it’s impossible to make money while trying to buy dips or slumps. It’s that buying at breakout offers the best combination of price upside and minimizing risk.

Breakout buying – a simple strategy

It’s always 10 cents above the point of prior resistance. Where that point lies depends on the kind of base you’re scrutinizing. 

In a cup-with-handle or saucer-with-handle base, the ideal buy point sits 10 cents above the top of the handle.

In a double-bottom base, the ideal buy points lie 10 cents above the middle of the base’s W shape. In a flat base, the ideal buy point is 10 cents above the top of the base.