What is a break out?

A break out occurs when a stock either fails to bounce off support or resistance. In this example, the stock is bouncing between its support at $49 and its resistance at $54. Every time it hits $49, the stock goes up, and everytime it hits $54 the stock goes down.

This continues until the stock hits its resistance of $54 and instead of going down it continues to go up. It breaks out of its trend and goes to $56. When a break out occurs it is normally a good sign that a stock will continue to go up. Many traders, called breakout traders, will buy when a stock has broken out and sell at a higher price. They will sell it when they are stoped out or when they hit the traders target price.

Targets For Breakouts

While you cannot accurately guess how high a stock will go after it breaks out many traders will attempt to place a target on their position. The target is normally measured by taking the resistance level and subtracting it from the support level.

In this example the resistance level was $54 and the support level was $49. That means the stock should make a move roughly $5 above the resistance level. In other words the target price in this situation would be about $5.

Knowing When to Get Out

If the stock breaks back down below support it is said to be an indicator that the breakout has failed. However since the actual line of resistance is kind of a subjective line the stock may pull back or even go below your resistance line at times only to shoot back up again afterwards.

To avoid getting called out too early traders will set their stops somewhere below the resistance line. There are different theories about how far below the resistance line a trader should set their stops, but the best thing to do is find a system that works for you and that makes you money in the long run.