There have been several previous articles warning traders against jumping into breakout trades since the breakouts often fail, Beware the Breakout. However, many traders still insist on trading them as they are worried about missing opportunities when prices do not happen to retest the broken supply as demand. I do not advise trading breakouts, but if you are going to, there is at least one thing you can focus on to increase your chances for success.
Volume is important when trading. Prices can only move up when buyers become aggressive and raise bids to chase diminishing supply. Prices drop when sellers are desperate to get rid of stock and drop their prices to attract scarce buyers. Often in a breakout, the price moves above a prior supply level that has already been weakened. When investors and traders see that new high being made, they jump on board and the volume spikes.
The problem is that when all of the potential buyers have already jumped in on the breakout, there is no way the prices can continue higher. Remember, we need aggressive buyers to push prices higher…they have already done so and are now worried sellers who may panic and send prices lower. This is why many breakout trades fail.
So, what should we look for in volume if not a spike after a breakout? What about increased volume before the breakout? If the volume starts to increase before prices do breakout, then there is a chance of institutional support for the price movement and people who are profitable in the trade even if price returns to the breakout point.
Volume can also be used to judge whether breakdowns from demand levels are likely to continue or not. This can be important for those wishing to enter shorts as often these breakdowns will not retest.
It is not a perfect indication that a breakout trade will or will not work, but the volume can be used as an odds enhancer to assist you in your trading. I typically wait for the retest of the broken level as an opportunity to enter the trade. This retest gives me confidence that the broken supply level will hold as a demand zone and thus a higher probability of the trade working.
– Brandon Wendell email@example.com