Stochastic Breakout Explained
A breakout is a trading setup that occurs at a crucial resistance level when the
price breaks and gains support above a resistance. It is a bullish breakout. A bearish
breakout also known as breakdown occurs as the price breaks below an initial key
support level that turns into resistance.
The takeaway here is a key resistance level turns into a support when a convincing
bullish breakout occurs, but a support changes into a resistance during a compelling
bearish breakout (breakdown).
This article clarifies both bullish and bearish stochastic breakouts.
Bullish Stochastic Breakout
A bullish stochastic breakout takes place when the following occur:
1/ the stochastic indicator is overbought
above seventy-five level,
2/ the overbought stochastic trade setup
occurs in the vicinity of a significant resistance level,
3/ the price breaks above and pulls away from the major resistance level,
4/ and the price pulls back to retest the key resistance level that changes into
support.
View the chart below
Image = "a daily chart is showing a bullish stochastic breakoout"
From 22 October 2014 to 14 November 2014, the stochastic indicator (8, 3, 3)
was overbought above seventy-five level. However, on the 30 October 2014,
Visa Inc stock (V) gapped up from the 53.67 price level. On that day, the stock
closed at 59.16. A valid bullish stochastic breakout was in place since that date,
and the stock rose to the 63.11 price level within seven days. Indeed, day and
swing traders that were selling because the stochastic momentum oscillator was
overbought was forced to close their bearish trades. That also provided more "fuel" for
the bullish price action. On the other hand, smart day and swing traders who mastered
the bullish stochastic breakout took a substiantial profit at the end of the day.
Explaining The Bullish Stochastic Breakout
The stochastic oscillator breakout occurs when it is overbought. Therefore,
traders that always sell because the indicator is overbought have to close their
bearish trades as soon as possible as the price begins to rise above the resistance
level. Indeed, to close a bearish trade, one has to buy back. Naturally, those traders
provide the "fuel" for the dynamic bullish price action. On the other hand, the smart
traders who know how to trade the stochastic accumulate more profit throughout
the subsequent volatility.
Warning:
"the stochastic bullish breakout is a trading setup. The next step is to validate
it before applying multiple times frame trading method.
The stochastic bullish breakout is not a trading signal but a trade setup"
In general, there is a surge in trading volume when the price is retesting the major
level.
Note that sometimes, the price may gain support above the key resistance level then
rises to the first nearest key resistance level before falling back below the resistance
level. Undoubtedly, that is a typical breakout failure. In addition, traders who avail
themselves of a top-down trading method will be able to contain the risk and manage
the trade without too much strain.
Warning:
"It is indispensable that traders use a free demo trading account to practice until the master how to
trade the bullish stochastic breakout like a professional trader"
Stochastic Bearish Breakout
The stochastic bearish breakout occurs as the following occur:
1/ the stochastic oscillator is oversold below
the twenty-five level,
2/ the oversold stochastic trade setup
occurs in the vicinity of a strategic support level,
3/ the price dips below the support and continues to decline for a while,
4/ then the price rallies up to the crucial support level that turns into resistance.
View the chart below
Image = "a weekly chart is illustrating a bearish stochastic breakout"
From 27 February 2015 to 10 July 2015, the weekly stochastic indicator
(8, 3, 3) was below the twenty-five level (oversold). Though, many bullish stochastic
traders were still buying Wal-Mart-Stores (WMT) stock, the price broke below
the significant support at 82.61 (orange line on the chart) that quickly turned
into a robust resistance level. That was a typical bearish stochastic breakout.
Notice that both in August and October 2015, the bearish momentum
became very strong and the stock fell at a faster rate due to the stochastic
bearish breakout. Consequently, those that were misusing the technical
oscillator were forced to sell their initial bullish positions. Moreover,
that also provided more "fuel" for the bearish price-action.
Explaining The Bearish Stochastic Breakout
The bearish stochastic oscillator breakout occurs when the indicator is oversold at a
time when the asset is overbought. Evidently, an overbought asset leads to a distribution.
Subsequently, traders that always buy because the stochastic indicator is oversold have
to close their bullish trades as soon as possible as the price begins to turn down at a quicker
rate below the critical support level. Indeed, to close a bullish trade, one has to sell. As a
result, those desperate bullish traders provide the "feed" for the new bearish price action.
On the other hand, the sharp traders who are familiar with how to trade the stochastic amass
more profit as the volatility surges.
Warning:
"Stochastic bearish breakout is not a trading signal but a trading setup. Therefore, it is
necessary that one validates bearish breakout trading setup before applying multiple times
frame trading method" {Author = George Beaulieu = Founder of stochastic-macd.com}
Very often, there is also a gush in the trading volume when the price retests the key support level.
Infrequently, a bearish breakout will be unsuccessful as the price swiftly turns around on or near
the first and nearest support below the initial main support level. That is a bearish breakout trap
or failure. Once again, day or swing traders who bring into play multiple times frame trading
method can subdue the risk and handle the trade without fear.
Attention please
When a stochastic bearish breakout occurs, the bearish breakout traders are trapped or
squeezed to the point where their stop-losses are taken out. This provides a bullish momentum
fuel that propels the price in the opposite direction. The contrary is also true when a bullish
breakout failure is in place.
Essential Step To Avoid Stochastic Breakout Failures
1/ always confirm the breakout trade setups on a higher time frame,
2/ employ a top down trading strategy,
3/ never make use of a single period,
4/ never apply the technical analysis alone,
5/ always combine the technical trading with the fundamentals. At least perform
Google finance acid test plus check the economic news,
6/ exploit the trading triangle,
7/ secure first profit or take profit gradually at the first and nearest key level,
8/ always make use of stop loss and do not assume anything,
9/ close the trade if the signal fails and do not continue to move the stop loss,
10/ remember that the failure of a bearish breakout is a bullish trade setup and
vice versa,
11/ do not fight the market. Once the failure is confirmed, one may quickly reverse
the opening strategy and take the other side.
12/ Always be aware of other market participants. Try to go into their minds plus
do not be overconfident. {Author = George Beaulieu = Founder of stochastic-macd.com}
Cut losses, admit errors and move on.
Surely, there will be another stochastic breakout-trading setup round the corner.
Conclusion
The stochastic indicator is very popular momentum technical oscillator, but it is also
the most misused technical indicator. As one becomes an expert stochastic trader,
one will make a profit from the stochastic breakout trading setups. Those setups
are very remunerative. To become an expert stochastic indicator breakout trader,
one must adopt a multi-talented trading mindset by combining the technical and
fundamental analysis but also the top down trading and stochastic strategies.
Finally, advanced day and swing traders who master the Elliott Wave principle and
138.2% Fibonacci extensions will trade the stochastic breakout trade setups more accurately.
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