Identifying Market Breakouts And Breakdowns In Trading
Stock and commodities veteran Phil Storer says that when entering trades, it's best to use price charts to identity market breakouts, and he recommends working with a checklist and paying attention to market momentum.
Storer says, if you hope to look into the future, it's useful to know something about the past. For instance, it helps to know how far a given market usually moves between price corrections. Since market action tends to repeat itself, it makes sense to know something about earlier behavior. And that's where charts come in handy.
Armed with a chart, a trader also needs a good checklist to make sure he doesn't overlook anything important to the trade, Storer says. At the top of his list, he must decide where to enter the market. Should it be done in an area of price support that's holding on the chart? Or should it be done on a price breakout? Entering a buy order on a market pullback of 40% to 60% often makes sense, he says.
But don't risk too much on a market breakout or breakdown in a trade, Storer advises. And he recommends always having both a probable and possible target for the trade--or two clear goals.
Storer says to understand market setbacks and advances, and to assess when they might occur, it's important to remember that markets go down when sellers outnumber buyers, and markets rise when buyers outnumber sellers. We all know this, but the concept is easily forgotten, he says. Another simple concept that shouldn't be overlooked is that, after entering a market, buyers become sellers and sellers become buyers.
He explains what happens from there, saying as more and more buyers enter a market, the number of potential sellers continues to grow and the available buyers begin to decline. We could expect the number of buyers to dwindle as the market moves up, while the number of traders interested in selling increases until the two groups become equal in size, Storer says. That's when the market stops moving but, he says, it wont stop for long!
Storer says, at that point, traders who still want to buy have become more cautious since the price is now higher, and those who bought earlier are hoping to protect the profits that they've earned. In order to take those profits, however, they must sell.
Meanwhile in this scenario, a group of traders exists that want to go short--or sell high and buy back later at a lower price. Short sellers become more aggressive as the market strengthens, Storer says. He warns suddenly an overload of selling can appear, created by those who want to go short, combined with those who want to take profits. The few remaining, cautious buyers are outnumbered, and they're immediately devoured.
Storer says since a market is an open auction, the sellers begin to offer the market lower in an attempt to find others to buy their short positions. That's the main reason markets typically go down faster than they go up, he notes.
Obviously, not every trade will be a winner, Storer says. It's hugely important that a checklist be used to verify to yourself that there's no reason to feel you missed something that makes you feel guilty about a loss. If the loss was the result of a breakdown in discipline, that lets you know what you need to work on, he says. If the loss stemmed from a shortcoming in methods, it's imperative to make the needed adjustments, he advises.
Storer is Director of Trading for the stock and commodity division of Dillon Gage Inc., a full-service brokerage firm based in Dallas, Texas.
Storer says, if you hope to look into the future, it's useful to know something about the past. For instance, it helps to know how far a given market usually moves between price corrections. Since market action tends to repeat itself, it makes sense to know something about earlier behavior. And that's where charts come in handy.
Armed with a chart, a trader also needs a good checklist to make sure he doesn't overlook anything important to the trade, Storer says. At the top of his list, he must decide where to enter the market. Should it be done in an area of price support that's holding on the chart? Or should it be done on a price breakout? Entering a buy order on a market pullback of 40% to 60% often makes sense, he says.
But don't risk too much on a market breakout or breakdown in a trade, Storer advises. And he recommends always having both a probable and possible target for the trade--or two clear goals.
Storer says to understand market setbacks and advances, and to assess when they might occur, it's important to remember that markets go down when sellers outnumber buyers, and markets rise when buyers outnumber sellers. We all know this, but the concept is easily forgotten, he says. Another simple concept that shouldn't be overlooked is that, after entering a market, buyers become sellers and sellers become buyers.
He explains what happens from there, saying as more and more buyers enter a market, the number of potential sellers continues to grow and the available buyers begin to decline. We could expect the number of buyers to dwindle as the market moves up, while the number of traders interested in selling increases until the two groups become equal in size, Storer says. That's when the market stops moving but, he says, it wont stop for long!
Storer says, at that point, traders who still want to buy have become more cautious since the price is now higher, and those who bought earlier are hoping to protect the profits that they've earned. In order to take those profits, however, they must sell.
Meanwhile in this scenario, a group of traders exists that want to go short--or sell high and buy back later at a lower price. Short sellers become more aggressive as the market strengthens, Storer says. He warns suddenly an overload of selling can appear, created by those who want to go short, combined with those who want to take profits. The few remaining, cautious buyers are outnumbered, and they're immediately devoured.
Storer says since a market is an open auction, the sellers begin to offer the market lower in an attempt to find others to buy their short positions. That's the main reason markets typically go down faster than they go up, he notes.
Obviously, not every trade will be a winner, Storer says. It's hugely important that a checklist be used to verify to yourself that there's no reason to feel you missed something that makes you feel guilty about a loss. If the loss was the result of a breakdown in discipline, that lets you know what you need to work on, he says. If the loss stemmed from a shortcoming in methods, it's imperative to make the needed adjustments, he advises.
Storer is Director of Trading for the stock and commodity division of Dillon Gage Inc., a full-service brokerage firm based in Dallas, Texas.