The Breakout System on Steroids

April 11th, 2018

I love the Breakout strategy.

I love it because it’s the most researched, most eternal trading strategy ever invented.

I also love it because, when it works, it’s the most fun you’ll ever have in trading.

Seriously, what could be better than watching a winning trade run for days, weeks, or months?

As with all things, though, there are some downsides to trading this way.

One, it doesn’t win a lot. We need to be there for every breakout, so a lot of them will be false ones. Sub-50% win percentages are never fun, and that’s what you get with this methodology.

Two, it doesn’t trade very often. The best breakouts are the ones that happen on long-term charts.

If price breaks above the high of, say, the past 20 bars on a Daily chart, something is probably going on.

If price breaks out above the high of the past 20 bars on a 5-minute chart, however, nothing is probably going on.

But if we use the long term charts for their effectiveness, that means we don’t trade very often. How often is not very often?

On a Daily chart, we might get between 2-6 trades a year. If we’re only going in one direction (only Long, for example), then we might go a whole year and not get a single entry.

And if I know traders, that’s a bad, bad thing.

Even if a breakout system can provide all the income a trader could ever want, the traders I talk to would rather chew off their own foot than only trade 3 times a year.

So is there any way to speed things up?

Yes.

This week, we’re going to look at AAPL.

Stocks are great for breakouts because they, um, break out. They break out like crazy. And since the stock market has a long-side bias, it’s possible to only consider Long trades.

Fine. But how do we get more trades?

Well, instead of waiting for an instrument to break above a previous high, what if we decided to trade a breakout on a regularly scheduled basis?

Meaning: what if we took a trade every time AAPL broke out to a new monthly high?

The thinking goes: when we hit a new high for this month, we may be seeing the start of something–even if we’ve been in a downtrend.

If we’re waiting for a new high of the past 90 days and the stock plummets, it could be a year before we get back to that high again. That’s a lot of waiting–and a lot of potential missed profit as it comes back up.

By getting in on a monthly high, we get an early entry when the downtrend ceases. We get profit all the way up.

In addition, trading each new monthly high means that we will probably get a trade every month.

They won’t all be good trades, but, hey, at least we’re trading! No more waiting around till the cows come home.

Getting back to AAPL, for this style of breakout trading, we drop down to a 240-minute chart and get in on a monthly high. That could be the first day of the month or any other day. As long as it’s the high for the current month, we get in.

Then we use a hard stop in case things go badly.

And we use a timed exit because we want to lock in profit on these breakouts. We’re trading more often, so a lot of breakouts will be mediocre. A timed exit gives us a chance to be profitable on unspectacular trends.

Last, we use a trailing stop like we always do for breakout trading.

Using those rules on a hypothetical $10,000 account, we used full margin and actually traded $20,000 worth of stock on each trade. (The margin for Tradestation allows us that much margin if we’re holding trades overnight. We could use a smaller trade size, of course, but we’re going for it.)

How did it do?

From 2008-April, 2018, AAPL averaged over 35% per year with a drawdown under 40%. And, no surprise, it averaged about 1 trade per month. No long dry spells with this methodology.

For comparison, during that same period, the market averaged about 9% per year with a 50% drawdown.

Stocks are a great vehicle to use for breakouts. Not every stock trends as strongly as AAPL, but if you can find something that moves, scheduling a monthly breakout looks like it can make good money.

And, thankfully, it gives eager traders the action they need.