Trading breakouts is a common trading strategy that can provide an excellent reward to risk and profits. The basis for trading breakouts is that a sideways consolidation within an uptrend signals that demand is strong, which creates a new area of support.
That new support area can then become a new launch pad where prices can continue a move higher from. But when the trend is extended and the base is small, this pattern can happen.
I have taught the Breakout Bar Failure (BBF) pattern to many traders and investors and it can save you a bundle too. It is an early warning that something is wrong. It is better to exit a long position and reevaluate. The BBF works in a downtrend as well.
A BBF happened before the recent market drop and, while the result isn't always as extreme as what occurred, you can never know.
Here is the Breakout Bar Failure Pattern
Above is a chart of the S&P 500 shown with the ETF symbol SPY. The initial breakout that occurred at the start of 2018 was after a relatively small move up and consolidation. That consolidation created a new level of support that signaled strong demand.
The move higher stalled (first large red candle) but prices did not pull back; rather, they accelerated higher and became extended. A small consolidation formed and then the breakout.
Buying a breakout with this scenario is low odds, but strong trends can make amazing moves at times. I'll leave that money on the table every time.
But if you find yourself in such a situation, knowing the Breakout Bar Failure pattern will save you from what can become a disaster.
Once the breakout bar has formed — an inside bar forms within the range of the breakout bar — place a stop-loss under the low of the inside bar. When prices break under the inside bar's low, the breakout is failing and is an early warning signal.
Master Trader Advisory Market Edge Letter
Our Advisory Letter subscribers were warned of the danger based on other criteria shared with them before the BBF. They were advised to trail a prior bar's low in the daily time frame in anticipation of a decline.
Here is a quote from that letter
“Historical measurements of extension provide us with “reasonable and objective” guidelines as to when the probability of retracements are likely. However, during the rare times when the broader markets, a sector or an individual stock defies historical norms, it can be difficult to follow those guidelines; meaning, not enter when everything seems perfect and that “nothing can go wrong.”
“With the broader markets having pushed higher on Friday and looking like they are going to accelerate higher, a bar-by-bar trail stop under a prior day’s low is appropriate.”
Breakout Bar Failure
The BBF pattern is simple to see and learn, but may not be easy to do in the moment because of the prior strength — until you have experienced it for yourself. Now you know it. Knowledge can save you money and make you money – and it pays for a lifetime.
Description: Learn the “Crash Patterns” on stocks and broader markets and how to profit from trading stocks, ETFs, options, and volatility.
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All the best,
Managing Director of Master Trader
Pristine’s Founder and Creator of the Pristine Method
Chief Options Strategist
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