Trading breakouts has many advantages and disadvantages that new traders should be aware of before attempting to use breakouts in their own trading strategy.
These pros and cons can help new traders decide if they are interested in using breakouts.
The pros or advantages of trading breakouts are:
- Breakouts Are An Easy Technical Analysis Concept For New Traders To Learn
- Breakouts help traders capture the beginning of new trends in markets
- Breakout trading can be applied to any financial markets
- Breakouts can be used in various timeframes
- Breakouts offer potentially great risk-reward trades
- Breakout trading has created many successful traders over the past few decades
The cons or disadvantages of trading breakouts are:
- Breakouts can create many false trading signals
- Breakouts can have a low win rate
- Breakouts can cause overtrading for novice traders
These are the main advantages and disadvantages a new trader should consider before using breakout trading strategies.
Pros Of Trading Breakouts
Below are the pros/benefits of trading breakout as part of a trading or investing strategy.
Breakouts Are An Easy Technical Analysis Concept To Learn
A benefit of breakouts is many novice traders find that they are easy to learn and understand.
For a beginner, it is relatively easy to find chart patterns and rangebound markets with a clear breakout point on a price chart.
Most rookie traders will learn how to identify breakouts on price charts in a few days to a few weeks.
Breakouts are easy to learn because there is a clear and defined price level or "breakout price".
Typically learning how to spot breakouts simply involves finding a prominent area of support or resistance level on price charts and waiting for the price to break above or below the support/resistance levels.
Breakouts Help Traders Capture The Beginning Of New Trends In Markets
Another pro of benefit of breakouts is they can help a trader capture the beginning of a new price trend in the market.
Typically, when the price breakouts of a breakout level or price it signals a change in the price action from a price consolidation period to a new bullish or bearish trending market.
If the price breaks out successfully, it can be the beginning of quite a substantial trending move, depending on market conditions.
Prices passing through breakout levels in certain financial markets can signal the beginning of a 20%, 50% or 100%+ price trending move.
Examples of breakouts capturing the beginning of a new trend include:
- FB stock price breakout: Facebook stock price breakout on July 25th, 2013 led to a 550%+ bullish price trend over the next 5 years. Prior to the price breakout, the price of the stock had been consolidating for over a year.
- TSLA stock price breakout: Tesla stock price breakout on April 1st, 2013 led to a 600% price move over the next year. Previous to the price breakout, the price had been in a consolidation period for 3 years.
- Bitcoin price breakout: A Bitcoin price breakout occurred on July 26th, 2020 which led to over a 500% price increase over the next year. Prior to the breakout, the price of BTC had been in a choppy price consolidation for over 2 years.
These are just 3 examples of some of the powerful and large moves that can occur in financial markets after a price breakout.
Breakout Trading Can Be Applied To Any Financial Markets
Another pro or benefit to trading breakouts is breakout trading can be applied to any market.
While some types of technical analysis is restricted to specific markets, breakout trading does not have such restrictions.
Price breakouts occur in multiple markets from:
This means that learning breakout trading can be useful for traders interested in any capital market.
Breakouts Can Be Used In Various Timeframes
Another advantage of trading breakouts is they can be applied to multiple timeframes.
Some technical analysis concepts are restricted to a specific timeframe whereas breakouts can occur on any timeframe.
Breakouts can occur on timeframes from a 1 minute time chart up to monthly or even yearly price charts.
This means that any trader type from intraday scalpers to swing traders and position traders can apply breakout trading to their trading or investing strategy.
Breakouts Offer Potentially Great Risk-Reward Trades
One of the most popular advantages or pros of breakout trading is breakouts can offer a great risk to reward ratio in the markets.
With the examples mentioned above, a price breakout in a market can lead to a very large bullish or bearish price trending movement.
Due to this, it enables a trader to get a very high reward for very low risk, in some instances risking $1 to make $5 - $6.
This means that a trader can have a very low win rate and still be profitable in the long term.
A fundamental and pivotal part of successful trading is keeping losses smaller than gains and breakout trading enables this to happen.
Breakout Trading Has Created Many Successful Traders
Another positive with breakout trading is it is a core part of many successful traders' trading strategies.
Examples of top traders that use breakouts in their trading include:
- Dan Zanger
- Mark Minervini
- William O'Neil
In William O'Neil's book "How To Make Money In Stocks", he shows how using breakouts as part of a trading strategy can help a trader capture very large price moves in the stock market (1).
Mark Minervini also successfully trades using breakout trading and has won the investing championship on multiple occasions (2).
Dan Zanger also successfully trades breakouts using chart patterns and is famous for turning $10,775 into over $18 million in 2 years. These results were independently audited (3).
Cons Of Trading Breakouts
Below are the cons/disadvantages of trading breakout as part of a trading or investing strategy.
Breakouts Can Offer Many False Trading Signals
Using breakouts in technical analysis on its own without volume can lead to many false breakouts.
False breakouts are when the price of a market breaks out through a breakout price level and then immediately returns to the breakout level rather than continuing on in the direction of the breakout trend.
As breakouts have a low win rate, many breakouts fail. Not adding volume as a component to trading breakouts can mean new traders will take many false trading signals and get caught in more false breakouts.
Breakouts Have A Low Win Rate
A con/disadvantage of breakout trading is it tends to have a low win rate.
While this is not a problem if the risk-reward is good, many new traders discount the value of breakouts because they believe that traders need to have a high win rate to be profitable long term.
However, this is not true. Some of the best breakout traders in the world will have low win rates between 25% - 40%.
The most important part, as stated, is the risk versus reward ratio.
Breakouts Can Cause Overtrading For Novice Traders
Another con of breakout trading is it can cause new traders to start overtrading i.e. taking too many buy or shorting signals.
New traders tend to get excited and trade minor breakouts without adding a confirmation technical indicator like volume.
This leads to rookie traders attempting to take many breakout trades in various markets.
Ideally, traders should use breakouts with other indicators like volume as rising volume on breakouts tends to indicate that the breakout might make a large price move.
Trading breakouts has shown to be a successful trading and investing strategy for many traders and investors.
As a tip, it is recommended that a new trader should use volume with trading breakouts to add a confirmation signal to not get caught in many false breakouts.
The pros of trading breakouts far outweigh the cons and it is something every new trader or investor should look to incorporate into their own trading strategy.