Anatomy of a Breakout

● There are many variations of breakouts, but they all have one thing in
common-range expansion.
● All breakouts are essentially a break of some prior range in price.
● Pennants, flags, channels, etc… all form a range at the end of a volatility
contraction pattern and the breakout occurs once that range is broken.
● Our job is to determine what that range is and when the range has been
broken.
● The following checklists are presented in order of importance (technical,
fundamental, and environmental/macro factors).
 Breakout Checklist (Technical)
● Prior momentum (can use monthly, weekly, daily chart)
● Adequate volume (will liquidity or wide spreads be a problem when trading your target stock?)
○ An increase in average volume during the upward momentum is also very desirable, but not completely necessary.
● Defined, narrowing range - If you were to draw trend lines around the border of the range you do not
want the trend lines to be violated more than once or twice and no violations or only slight violations
are preferable.
● Moving average tightness - You want the range to be building along or into a tightening of a moving
average(s). Ideally a convergence of the 10 & 20 SMA or 50 SMA is what we want, although the
range can tighten against just the 10 SMA before breaking out.
● We are most concerned with price action closest to the right side of the chart. The further to the left
side of the chart we look, the less relevant that price action is. It is typically the last week or two that
we are focusing on.
● Clean, linear moves. We want to see prior upward momentum characterised by orderly price
increases with occasional and brief moves to and off of the 10 or 20 SMA.
 Breakout Checklist (Fundamental)
● EPS and sales growth - We want to see big earnings surprises and explosive
growth in the companies we trade. Triple digit EPS and sales growth are ideal
but not necessary.
● Innovation - We want to trade stocks of companies with innovative products,
services, or business models.
● Sector/Industry - We want the stocks we trade to be part of a larger sector or
industry theme. A great example of this would be weed stocks in 2013, 2018,
and 2021. EV stocks in 2020 is another example of a hot sector.
 Breakout Checklist (Environment/Macro)
● Indexes trending up above 50 SMA - The directional trend of the indexes shows us if
larger institutions and investors are in a buying or selling mood. Breakouts work best
when the indexes are trending upwards and are much more prone to failure when
trending downwards.
● When the market is pulling back or in a bear market biotech and commodities tend
to have a higher breakout success rate than other types of stocks.
● Federal Reserve’s actions - QE/QT, interest rates, etc…
● Government policy - Be aware of any policy changes that could create headwinds or
tailwinds for certain sectors and industries.
● Be aware of international relations and politics. Understand what is happening in
the domestic and global economy.