What are Breakouts and Breakdowns - Trading & Types

Did you know that the Stock Market can also have fake breakouts? But what are breakouts and how do you find out if a breakout is real or fake? Watch our engaging and easy-to-understand video from the #LearnWithUpstox series to get a clear understanding of Breakouts and Breakdowns.

Welcome back to a new blog of ‘Learn with Upstox’. Everyone wants to know breakout secrets, how to save themselves from fake breakouts, why do trades I buy on breakdown as soon as I buy them? 

If the line indicates the level, and the stock price hits the same resistance twice, then this is an important event. If the price passes resistance to travel to the other side of the line, this is called a breakout. The opposite of this is breakdown. 

Let’s say there is a support level. When the price hits the support level, everyone buys. When the price hits the support level a second time, this becomes an important level. When there is a third strike, and the price breaks through the support level line, we call it a breakdown. Simply put, breakout is upside and breakdown is downside.

 First, let's understand breakout better. When a breakout happens, what price action will be most favorable to you? Will it be a hammer, or a doge, or an engulfing candle? Basically, we need to form a bullish engulfing pattern for our breakout. Now, if you remember our blog on the Volume indicator, you’ll remember volume breakout. Now the price breakout should be supported by the volume breakout which means that the volume should be heavy when the price breakout happens, which visually is seen when the volume bars at the bottom of the chart breakout above the black line indicating volume line. This is the second quality, making the formation of a bullish engulfing candle pattern the first quality.  

 The third and the most hidden quality is consolidation. Let’s say that we are working on a fifteen-minute time frame, we are intraday trading, we notice that the market makes one bullish candle frame after another till a breakout occurs. A lot of people trust the upward trend, but will realize as time passes that after the breakout of the candle, we see a smaller green candle, a doge and then a huge big red candle and smaller red candles start going sideways. When this happens, many people face losses. Now, how can we avoid this?

 Consolidation. Whenever you see a breakout, it should be after a considerable consistent pattern of say three to four touch points is made, we know that it is a genuine breakout and the candle and volume breakout should confirm this. If there has been no consolidation, and there is a direct breakout, the probability of failure is higher. This is not true for every breakout, but I prefer working with larger probabilities, so we should take those breakout trades when there is a good consolidation.

 The fourth quality is multiple tests. The resistance level should be tested multiple times. Let’s say that in a fifteen-minute frame you can see the consolidation against the resistance level multiple times, say the day before as well, the resistance line had been touched at various times, and the day before that as well, the resistance level breakouts is due to a genuine breakout. The probability of the stock falling below resistance will become lower.

 When we speak about breakdown, the same theory applies to bearish engulfing candle patterns, the volume breakout, consolidation and multiple tests. The chart is a very good chart, and ticks all our quality checks.

 As you can see it has the morning star pattern for a breakout as well as an evening star pattern for a breakdown. Quality number 1 check.

 The volume is also great, and breaks past the black line, hence quality number 2 also check.

 There is very apparent and long consolidation before the breakout, making it a genuine breakout. Quality number 3 check.

 Has the level been retested in the chart, as you can see, it has been. So, this is a buy chart. As per this chart, as a Swing trader, in two days you could stand to make Rs. 370 per share, and as an Intraday trader, the chart shows a 3.13% increase.

 Looking at the second marked example, you will notice consolidation, level and then a breakout that is big.

 The third marked area shows the market consolidated for two days straight. This means there is something coming for which it is waiting. If there is a breakout after this, as there is in the chart, it will be a good one. In this chart it shows a 2.5% leap.

 In the next marked area, you can see the level tested, consolidation and a genuine breakdown. In the next two, you see the same patterns repeating themselves, one causing a breakout, the other a breakdown.

 In the next chart you will notice a big resistance in the start, at the open of the day. This is also very important. After this the market tries to climb twice, succeeding in the second time, causing a breakout. You will also notice there is a decent amount of consolidation here as well. You will buy at the top of the breakout candle. After this, in the last hour before closing, the market has risen 2%.

 In the last chart you can see that the market has been consolidated since the past two days. The market is within the box, which means it is a no trading zone. So, would you buy on breakout after this, or sell in the case of breakdown after this, comment below. I hope this actionable content is very helpful in your trading life.