TheCompleteBreakoutTrader:

DayTradingStrategiesthat

Work

JohnConnors

Copyright©2013AllRightsReserved.Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmitted,inanyformorinanymeans–byelectronic,mechanical,photocopying,recordingorotherwise–without

priorwrittenpermission.

Thisbookisforinformationpurposesonly,andisnotanoffertobuyorsellorasolicitationofanoffertobuyorsellanysecurityorinstrumentortoparticipateinanyparticulartradingstrategy.Theinformation

presentedinthisbookisforgeneralinformationpurposesonly.Theauthorisinnowayresponsibleforyourprofitsorlossesinthefinancialmarkets.

“Youneedonlyonesetuptomakealiving.”

-LindaRaschke

TableofContents

Dedication

Introduction

WhatisBreakoutTrading?

UnderstandingMarketModalities

Entry

StopLoss

TakeProfit

TheArtofCatchingMonsters

HowtoImproveYourTradeSuccessRate

PitfallstoAvoid

WheretoGoFromHere

Dedication

ToLindaRaschke,forhermentorship.Iwouldn'tbewhereIamtodaywithoutyou.

Introduction

Atraderreallyneedsonlyonesetup,onestrategy,tobesuccessful.Thesetupyouchooseisabsolutelycrucialtoyoursuccess.Somesetupsdonotoccurfrequentlyenough,

oraretootoughtotradepsychologically.Othersarenotuniversalenough,andworkonlyoccasionallyonsomeinstruments.Andstillothersdonotgiveyouenoughprofitsfortherisktaken,oraretoocomplextoexecuteunderlivemarketconditions.

Breakouttradingdoesnotsufferfromanyofthesedefects.Itisasimple,comprehensivetradingmethodthatyoucanuseinallmarkets,withpotentialprofitsfaroutweighingtherisks.

Someofthemostprofitabletradersinhistory,earlyandrecent,werebreakouttraders:

theywouldtakeapositionimmediatelywhentheyfeltatrendhasstarted.

Perhapsthemostfamoustraderofalltime,JesseLivermore,wouldtakeapositiononcethemarketsbrokeoutandstartedtrending,stayingawayfromrangepriceaction.Consider

whathesaysinhisnowfamousreminiscence:

“Thethingtodoistowatchthemarket,readthetapetodeterminethelimitsoftheget-nowhereprices,andmakeupyourmindthatyouwillnottakeinterestuntilthepricebreaksthroughthelimitineitherdirection.”

(ReminiscencesofStockOperator,140).

Livermoredidnotwaitforpullbackseither:

“Ineverbuyonreactionsorgoshortonrallies.”(HowtoTradeinStocks,20).

Hewouldtakeaposition

oncehehassatisfiedhimselfthatthemarketleftapricerangeandstartedtrending.Hewasabreakouttrader.

NicholasDarvas,anothertradinglegend,theauthorof“HowIMade$2,000,000intheStockMarket”,says:

“Myonlysoundreasonfor

buyingastockisthatitisrisinginprice.Ifthatishappening,nootherreasonisrequired.Ifthatisnothappening,nootherreasonisworthconsidering.”

Andinrecenttimes,theTurtlesbecamefamousassystematicbreakouttraders,makingmillionsinthe

commoditiesmarkets.

Breakouttradingisagreatwaytogoifyouarelookingforatestedandaprofitabletradingmethod.

WhatisBreakoutTrading?

Breakouttradingcanbesummarizedasgettinginoncethemarketstartsmoving,andgettingoutwhenitstops.Whilesimplistic,thisistheepitomeofsuccessful

trading.Youcannotmakemoneywhenthemarketdoesn'tmove.Andthebestplacetogetinisrightatthestart.

Yet,breakouttradingseemstohaveabadnamenowadays.PopularwriterslikeAlBrookscontinuetoteachthat'mostbreakouts

fail',soit'sabadideatotradethem.

'Waitforapullback,'theysay.

Theproblemisthatmanystrongtrendsdon'thavepullbacks,orhavepullbacksthatarelate,offeringlesserprofits.Itcandriveaday

tradermadwaitingforapullbackinastrongtrendthatneverhappens,whilethepriceskyrockets.Itisn'tlogicaltoidentifyatrendstartandnotenter,waitingforaspecificchartpatterntoformthatmaynevermaterialize.

Thetrendsonlong-termchartsandshort-termcharts

lookthesame,andtheyarebothtradable.Butyoudon'tneedtotradelong-termtimeframestobeabreakouttrader.Infact,thedifferenceisthatadaytraderhasmanymoreopportunities.Along-termtimeframetradermaycatchatrendperhapsonly1or2timesayear.Aday

tradermaygetanopportunityseveraltimesaweek.Infact,jumpingonastrong,newtrendatthestartistheeasiestwaytomakemoneyinthemarkets.

Sothequestionisn'tifoneshouldenteratrend.Thequestionishowandwhen.Thisbookprovidesyouwith

thebeststrategyfordoingso.

UnderstandingMarketModalities

Byfar,themostimportantskillyoucandevelopasatraderisunderstandingthemarketmodalities.Thisreferstobeingabletorecognizewhetherornotthemarketis

trending.Ifitis,thereislotofopportunity.

Don'tsay:“Iknowallthat”.Thetruthisthatmosttradersknowthat,yetover90%losemoneyconsistently.

Why?

It'sbecausetheydon'thavea

well-definedmethodfordeterminingthemarketmodalityandstickingtoit.

Considerthefollowing:

Chart1:RangeBreakingintoTrend

Forsometime,themarkethasmovedwithintwo,well-definedpricepoints.Thepricehasoscillatedbetweenthesupportatthebottomand

resistanceatthetop.

Whenthepricemovesthisway,themarketisnottrending.Itisinarange.

Aftersometime,thepricebrokestronglythroughthesupportandatrendhasbegun.Noticetheredbearishbarthatstronglybrokethe

rangerectangle.Ithasclosed'outofthebox'andhadasizelargerthananypreviousbarsinthechart.

Nowconsiderthissituation:

Chart2:Range,Bloody

Range

Whereisthetrend?Whereisthebreakout?

Thereisn'tone.Thepriceisstillmovingwithintwoboundaries.(Theremaybeatrendonahighertimeframe,

butthat'sanothermatterthatwewillconsiderlater.)

Yourjobasabreakouttraderistogetinoncetherangeisbroken,andatrendbegins.Whenthemarketisstillranging,asinChart2,yourjobistowait.

Becausetrendsbeginas

breaksoutofranges(breakouts),thefirstskilltomasteristoidentifythemarketmodality.Isthemarkettrending?Ifnot,whereistherange?Inotherwords,betweenwhichtwopointshasthepricebeenmovingrecently?Youcaneasilydothatbydrawinga

pricerectangle.Thetopandthebottomshouldbetouchingoneorseveralpoints.Dothatonthechartsyoutrade.Therectanglewillserveastheprimaryreferencepointforthebreakout.

Entry

Definition:weenteronthecloseofastrongbarthathasclosedoutsideofarecentpricerange(outsidethepricerectangle).

WhattoLookFor:

1. Awell-definedrange.

2. Astrongbreakoutbarthatclosesoutsideofthatrange.

3. Theentrybarshouldbebiggerthanthebarsintherangebutnot

climactic,andhaveastrongclose.

Allthreeentrycriteriaareimportant,butthemostcrucialoneis#3.Thebreakoutoftherangemustbeclearandconvincing(thebarshouldbebiggerthan

previousbars),butnotclimactic(thebarshouldnotbedisproportionatelybig).

Let'slookatsomeexamples.

Examples:

Chart3:Entryonbar1.

Inchart3,theentryhappensonthecloseofbar1.Therectangleindicatestherecentpricerange.Bar1has

stronglybrokenoutoftherangeandclosedoutside.Noticethatthebarhasalargerbodythananyofthebarsintherange,andthatithasatinywickatthebottom,indicatingstrongsellingpressureintothebarclose.

Alsonoticethatwedon'tcarewhatmarketortimeframe

thisis.Youwillfindthispatternacrossallinstrumentsandalltimeframes.

Chart4:Entryonbar2close.

Inthiscase,bar1closedoutside,butsimplywasn'tstrongenough.Soweenteronthecloseofbar2,whichisaconvincingbreakoutbar.Again,noticethestrongclose,sizeofthebar,andin

thiscase,nowickatthebottomofthebar,indicateverystrongsellingpressureintotheclose.

Sofarsogood.Youdefinetherange,andthenenteronthecloseofthebarclosingoutsideofit.

Nowconsiderthefollowingchart:

Chart5:Entry?

Chart5hasawelldefinedrange.Bar1breaksoutofthatrangeandcloseshigh.Isthisagoodentry?

No,itisn't.Thereisa

differencebetweenatrendandaspike.Bar1inChart5isaspike,notatrendstart.Spikeisasharpmarketmove,toofartoofast,typicallywithapoorentryforyou.Ifyouboughtthecloseofbar1,youwouldbebuyingtoofaroutsideoftherange.Bar1isdisproportionatelybig

relativetopreviousbars.Don'tenter.

Let'slookatonemorecase:

Chart6:Enteronbar1?

InChart6,isbar1agoodentry?

No,itisn't.That'sbecausethepriceisextremelyclosetotherange,rightattheborder.

Youwanttopricetomoveawayfromtherangebeforeyouenter.Thinkoftherangeasagravityfield.Ittendstopullpricebackin,unlessthereisastrongtakeoff.Bar1isnotastrongtakeoff.ThecloseofBar2istheproperentry.

Advantages

Thegreatestadvantageisthatyougetinatthestartofatrend.Thismeansyouareenteratagreatprice,andcanholdyourpositionforlargeprofits.

Disadvantages

Thegreatestdisadvantageisthatyouwillsometimesenteronabreakoutthatwillnotdevelopintoatrend(falsebreakout–fakeout).Consider

thefollowingchart:

Chart7:Fakeout

InChart7,therectangledefinestherange.Bar1isabreakoutbar.But,aftertheentry,thetrendhasnofollowthrough,andfallsbackintotherange.Sometimes,thiswillhappen.Therearenoperfectsetupsthatwork

100%ofthetime.

(Thoughinthiscase,youshouldhavenoticedthatbar1didnothavealargerbodythananyofthebarsintherange,whichmighthavewarnedusthatthissetupisnotgood.Whenyoulookatachart,youwantthebreakouttobedominantandtherange

lookpuny.Inthiscase,therangelooksvastandthebreakoutisminisculeincomparison.Whetherthesetupislikelytoworkisallinthedetails.)

Thisleadsustoaveryimportantquestion:wheredo

weexit?

StopLoss

Howdoweknowwhenthetradehasn'tworkedout?Clearly,thetradeisn'tworkingifthepricehasrevertedbackintotherange.Typically,strongtrendswillneverreturntotherangefrom

whichtheystarted.

Sometimes,themarketwilltesttherangeandevenpenetrateitafewticksbeforeittakesoff.Soyourstopshouldbeinsidetherangeatleastafewticks.Irecommendastop10to15%insidetherange.Thisway,youwillnotbeshakenout

easily,butwillgettakenoutwhenitisclearthetrendhasfailed.

Asanexample,considerthefollowingchart:

Chart8:StopPlacement

InChart8,weenteronthecloseofbar1asthepricebreaksoutandclosesstronglyoutsidetherange.Weplacethestop10to15%insidetherange,choosingapointthat

wouldshowthatourtradehasn'tworkedout.

TakeProfit

Themostdifficultproblemintradingis:wheredowetakeprofits?

Goodtrendshavelargemoves,typicallylargerthanmosttradersimagineor

anticipate.Ifyourstoplossisoneunit,howbigshouldbeyourprofit?

Whenyoucatchagreattrend,youwanttobepaidmorethanwhateveritisyouarerisking.Ifyouarerisking1unit,Isuggestthatyourminimumtakeprofitpointshouldbe2units.Ifyouare

risking15ticks,yourtakeprofitpointshouldbe30ticksawayfromyourentry,andsoon.

Soconsideringthepreviouschart,wewouldhavethefollowing:

Chart9:TakeProfitPointatTwicetheDistancefromStop

Howwillthisworkoutinpractice?Supposethatyourprofitsaretwiceasbigasyourlossesandthatyouwin

on50%ofyourtrades.Here'stheresultofanequitysimulationusingthoseparameters,running1000trials,startingwithequity100:

Simulation#1:1000trials,50%WinningTrades,withWinsTwiceasLargeasLosses

Inotherwords,ifyoucanachieve50%winningratewiththoseparameters,you

aredoingfantastic.Youraccountwillgrowatasteadypace.

Forcomparison,supposeyouwinonlyon40%ofyourtrades.

Simulation#2:1000trials,40%WinningTrades,withWinsTwiceasLargeasLosses

Theequitycurveisstillgenerallysloppingupwards,thoughnotassharply.

Factoringthetransactioncostintotheequationislikelytomake40%winrateabreak-evenproposition.

Sotradinginawaywhereyourprofitsaretwiceaslargeasyourlosses,youwillwanttoaimfor50%hitrate.

Practically,thismeanstakingonlytradeswherealltheentrycriteriaaremet,andthenmanagingthepositionstrictlyaccordingtoyourplan.Tradingisagameofsmalledges,andtosucceed,youneedtominimizemistakesandtofollowyourplan100%.

TheArtofCatchingMonsters

Asyouevolve,youwillstarttradingmorethanjusttheminimumposition.Forinstance,asafuturestrader,youwilltrademorethanonecontract.Thefirstoneyou

canexitasdescribedabove:attwicethesizeofyourrisk.

Whatabouttheotherhalfofyourposition?

Aftertakingmoneyoffthetablewiththefirsthalf,youshouldconsiderthesecondhalfasarunner.Theproblemisnobodyhasanyideahow

faritwillrun.Considerthefollowingchart:

Chart10:Whoimagined?

InChart10,ifyouenteredonthecloseofbar1,wouldyouimaginehowfarthetrendwouldrun?

Thereareseveralwaysthat

youcancatchmonsters.

Afterthefirsthalfofyourpositionisclosedwithprofit,moveyourstoptobreakeven.Youwanttotakeafreeposition,meaningriskingnothingwhilehavingapotentiallyunlimitedupside.

Noticehowinchart10the

EMA(20)(ExponentialMovingAverage,Period20)heldthetrend.

Often,EMAactsasasupport/resistanceinatrend.ThetrendsthatrunfarsometimesdonottouchtheEMAforalongtime,sometimespushingintothedayclose.

Soexittherestofyourpositionattheendoftheday(bar2onchart10),orwhenabarclosesontheothersideoftheEMA,asinchart11:

Chart11:ExitwhenabarclosesontheothersideoftheEMA(20).

InChart11,weenteronbar1close.Bar2signaledanexitwhenitclosedbelowtheEMA.

Thisexitstrategyisveryrobust,andyouwillcatchsomemonsterrunners.

HowtoImproveYourTradeSuccessRate

Onethingyoucandotoimproveyoursuccessrateistoconsideralargercontext.Inotherwords,lookatthemarketyouaretradingona

highertimeframe.Ifyoutrade5minutes,lookatadaychart.Ifyoutrade30minutecharts,lookataweekchart.

Supposethehighertimeframelookslikethis:

Chart12:HintsfromaHigherTimeframe

LookingatChart12,largercontextindicatesthatthemarketisinaverystronguptrend.Shouldyoubetakingshortsetups?

Probablynot,evenifitlooksperfect.Youshouldfeelhesitanttradingagainststrongtrendsthatexistonhighertimeframes.That'sbecausethechancesofyourtradegoingfaragainstabigger,strongertrendarenotgood.Don'tpissagainstthewind.

Takingbreakoutsonlyinthe

directionofalargertrendcaneasilybethedifferencebetweensuccessandfailureinyourtradingcareer.

PitfallstoAvoid

Therearereallyonly2majormistakesyoucanmake:

Takingpoorsetups.

Mismanagingthetradeonceyouarein.

Youcannotaffordtotakepoorlookingsetups.Forasetuptobegood,allcriteriamustbemet.Inotherwords,therangehastobedefined,andthebreakoutofithastobeclearandstrong,butnotaspike.

Intermsofthetrademismanagement,thetwo

biggestmistakesaremovingthestoptobooksmallprofitandnotholdingforamonsterwiththesecondhalfofyourposition.

Socommittotakingonlygreatsetups,andmakeupyourmindtomanagethetradeaccordingtofixedrulesbeforeyougetin.Trading

timeshouldbeonlyaboutexecution.Youshouldn'tnotbe'thinking'orcomingupwithnewrulesorstrategieswhiletrading.

WheretoGoFromHere

Ifyouhavecompletedthebook,andunderstandthematerials,itistimeforyoutogothroughthechartsofyourfavoriteinstrument(s).

Markthemup.

Identifytherangesandthebreakouts.

Considerthesetups.Lookforsubtledifferencesbetweengoodandpoorsetups.Savethecharts.Createafolderwith“Goodsetups”and“Poorsetups”onyour

desktop.Lookthroughthefolderseveryday.Thisway,youaresolidifyingyourunderstandingandlearningwhatworksandwhatdoesn't.

Beforeyoustarttradingthestrategylive,Istronglyrecommenddemo-trading.Youshouldnotbeputtinganyrealmoneyatstakeuntil

youhavebecomesuccessfulonthedemo.Isuggestaminimumof1-monthbreakouttradingonyourfavoriteinstrumentbeforeyougolive.Attheendofthemonth,youshouldbeprofitableusingaconsistentsetofrules.Andremember,youneedtomasterjustone

strategytomakealiving!

HappyTrading!:)

“Thesecretingredientisyou.”

-KungFuPanda