In technical analysis (TA), a breakout refers to the price of an asset moving above a resistance area, or below a support area. A breakout may indicate that the price of the asset will start trending in the direction of the breakout.
Breakouts that are accompanied by high volume may be considered a stronger signal than breakouts with average volume. If the volume is high, there is a higher chance that price will start trending in the breakout direction.
Breakouts can happen as a result of range or channel breakouts or price pattern breakouts, such as triangles, flags, wedges, or head and shoulders patterns. Breakouts are typically preceded by a period of decreased volatility.
Usually, the longer the pattern has developed, the more explosive the breakout will be. If the levels are clearly defined, many traders may use the same price levels to set their stop-loss orders. Once those stop orders start getting triggered, they might create a cascading effect resulting in a rapid price movement.
The hypothesis behind breakout trading is quite simple. If support and resistance levels keep price contained in a range, the break of that range might indicate a larger move.
Breakout trading can be applied to virtually any timeframe and style of trading.
A breakout can be either a buy or sell signal, depending on the direction of the move. A breakout trader may enter a long or short position once price has moved outside of the defined support or resistance area.
It is important to note that, similar to other methods in technical analysis, breakouts can be subjective. The support and resistance levels and the chart patterns that provide the basis for the breakouts might be interpreted differently by different traders.
If price breaks outside of a defined range but quickly reverses, it may be considered a fakeout, or false breakout. This occurs when price moves out of a defined range, but after a short period, moves back into the range.
As a precautionary measure against fakeouts, some traders may wait for confirmation of the breakout on higher timeframes to enter a trade. This can also mean waiting for the breakout level to be retested as newly formed support or resistance (depending on the direction) as an entry point.