Possibly the best reason not to lose all your money in your first few years of trading is that the time spent practicing (and hopefully not blowing up your account)  allows you to develop a style or strategy that suits your personality and lifestyle.
I used to be a buyer of breakouts. I followed William O’Neil. I bought strength. Weakness was bought by morons who did not understand the power of the technical breakout. I traded this way for several years, and was profitable, trouncing the indexes. However, I discovered that buying breakouts make me uncomfortable. There are two reasons for this. The first reason is my tendency to want to anticipate the breakout, buying early, often got me stuck in a trade going nowhere. The second reason is that after the stock would breakout, it would suddenly seem expensive to me, and I developed fears of constantly top-ticking my entries.
Eventually, my psychology got the better of me, and I was buying strength, buying breakouts, but scared of top-ticking the trade. Therefore, on any signs of a pullback, I would inevitably sell at the very bottom. The realization of this developing problem hit me around the time I started wanting to develop mechanical systems to trade.
Anyway, I decided to make a concious effort to begin buying pullbacks, especially those that come just after a breakout, like this setup I posted last night: Russian ETF: Nice Entry Setup. Incidentally, I did buy some RSX on the open.
It has taken me about a year to be able to buy pullbacks comfortably. In order to get to this point, I have had to develop a trust of several conditions that must be present for me to buy.
Like many traders, I missed the breakout in coal stocks, and watched in disbelief as they soared. However, BTU has offered a couple of entries, since the breakout. On the chart above, BTU broke out, and then made a perfect pullback to the 50 day average and a long term support line. That is one of my conditions; before I buy a pullback, the stock must bounce at an obvious area of support. It should be obvious, as you want other traders seeing the same thing, piling in with you. Notice too that RSI(2) was nearing oversold, which is a second condition.
Unfortunately, I missed the first setup in BTU. I’ve been watching for a second chance, and it came on Friday, as BTU pulled back sharply, nearing the area of a previous pivot point. RSI(2) was extremely oversold. I started a small position, and then doubled it on Tuesday, when BTU was able to hold just above its 20 day moving average. This was a money setup, and the trade has paid off today.
My three conditions for buying a pullback in a stock that has recently broken out:
1. Pullback to support, trendline or pivot point  Â
2. Very oversold on whatever your favorite indicator is. Mine is RSI(2).
3. Pullback to a major moving average, such as the 20, 50, or 200 day. Anything less than the 20 is not enough for me.
Now, I no longer anticipate the breakout and buy early, and I do not stress if I miss the breakout. I have found that these adaptations have made my trading more relaxing and comfortable. Time will tell if I can still turn large profits buying the pullback instead of the breakout.Â
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Nice. Five stars.
Plus with pullbacks to support, your stops are more easily defined.
If you don’t mind me asking, what screener/methodology do you use to find watchlist stocks?
Thanks in advance.
Dave, my cup with handle/breakout screener is proprietary. However, I can tell you that you will find most of these stocks by screening for X weeks new highs. You might start with 52 week highs, and work backwards. Often, stocks that are getting ready to breakout will be found before they make 52 week highs. Since William O’Neill believes a solid base needs 6-8 weeks to form, you might try screening for new 8 week highs. This screen will catch those stocks that have based for a bit, and are moving, but are not yet near 52 week highs. Anyway, its not an exact science, but hopefully you see what I mean.
Once you find a breakout, or one that is close to breaking out, write the symbol down, and revisit it nightly, or every other night, or weekly. Typically what will happen is you will weed some out, and will be left with the ones you like the most.
As I wrote in the post, it has gotten easier for me to just wait until they breakout, and then catch them on the X weeks high screen. Then I watch them until they pullback.
Thank you much for the response.
Wood,
What system do you use as your screener?
I buy all consolidations below the 20 day. I like buying breakouts too. Nice call on RSX.
I am with you 100% on the breakouts. One of the things I have noticed (through backtesting) is that 78% of all breakouts retrace at least 25% of their breakout move the following day and 60% retrace at least 50%. Knowing this has altered my approach to them a bit and allowed me to be more patient with them. The one other big thing is breakouts require a wide stop (I use a 2-day low) so when using percent risk position sizing, you inevitably end up with much smaller positions for the same risk level as buying on a retracement where you can use a much tighter stop and put on larger postions at the same risk level, ie greater risk reward ratio.
Bhh- have you been able to code anything to test a pullback after a breakout? I have literally spent a year *thinking* about how I would code it, but i haven’t tried yet.
I guess the other thing about buying pullbacks is that if it works, it is a confirmation of the breakout. IMO, the breakout is not confirmed until it pulls back and doesn’t breakdown back into its base.
I’ve looked at using limit orders at various percentages below breakout signal high with a positive increase in expectancy. I’ve also considered making those limit orders remain active for n-days after breakout.
One other method I haven’t tested yet is to use a breakout in the last n-days as a setup condition and then use a swing low entry.
If Close[1] < Close[2] And Close[0] < Close[1] Then Buy with a stop order at yesterday's high. The buy/stop order is critical here because it confirms the bounce.
bhh- that’s nice and simple. Thanks!
No problem. I can’t take credit for the swing low entry, Pradeep Bonde from Stockbee gave me that idea.
Have you been watching the right shoulder forming on the Q’s the last few days? If so, would you say it is now invalid because of the lack of symmetry between the left and right shoulders or still valid and a possible head and shoulders pattern building on the 30 minute chart (going back 20 days)?
Hi! viramune