Understanding volatility breakout system

volatility trader, volatility breakout systems, volatility breakout strategies, trading on volatility

Play the breakout

A Thinking Trader and/or his  Strategy must decide if the breakout is a success or failure before the rest of the market does!

 

The system (trader) is not concerned with forecast or analysis; he is only concerned with the immediate price action after a breakout. Volatility Breakout or range expansion strategy is designed to take advantage of sharp jumps in price action.

 

Characteristics.  ( see Eclipsed III Day Trader )

I measure the characteristics or conditions of markets by the difference or spread between two moving averages, percent rate of change, gap openings, or an increase in the daily (weekly, monthly) high to low range or indicators like ADX, Chop Index and %C indicator.

Volatility breakout systems are based on the working premise that if the market moves a certain amount in one direction, a certain measure in a single direction or a particular percentage from a previous price level pointing one way, the odds favour some continuation of the move in the same direction for a period of time. The continuation period depends of the time frame being traded: intra-day trade or multi day swing trade for example.

Some of the most well know break out patterns were propagated by William J. O’Neil and his protégé David Ryan. Breakout methods for day trader patterns were the cutting edge in the 1980s.

As day traders we look for range days: a trading session where the market opens on its low and closes on its high and an intraday breakout takes the trader long. Alternately, the market opens on its high and closes on its low and an intraday breakdown takes the trader short. As a natural rule ALL day trading systems exit no later than end of day  but can exit anytime from entry to the end of day.

Keeping in mind a sense of proportion, a swing trade breakout system is looking for anything longer than a day range to capitalize on. A range week for example can be defined where the open on Monday is at the low of the week and the close Friday at the high of the week and the inverse is true for a down range week. Just like the day trader, the swing trader has a breakout signal that takes him long or short to take advantage of the range. As a side bar, Monday does not need to be the opening day and set-ups for a two or three day range can be used.

Two primary technical rules. ( see Eclipsed III Day Trader )

So with a breakout system, a trade is always taken in the direction that the market is moving at the time. It is usually entered via a buy or sell stop or with trade robots / automated trading software the orders are executed at the market once the price is hit. The part of the price action the trader is playing for is based the principle that momentum tends to precede price.

This working premise goes back to technical analyst like 1970’s trade advisor Marty Zweig, in that a surge of momentum is followed by price.

Another rule I have written and expanded upon many times is a extrapolation from Elliott Wave Theory: the rule of Alternation. It uses “Alternation” to validate their description of corrective waves. However, the rule is much more pervasive in market analysis. I have cited that the behavior of the market is one that cycles from rest to motion and back to rest.

In other words the market tends to alternate between periods of equilibrium (a balance in the forces of supply and demand) and a state of disequilibrium or an imbalance between supply and demand. When the market is not balanced, the trader witness’s increases in measurements in the patterns mentioned above. More important to traders, the imbalance causes an expansion of the high/low range. It is during these periods of expansion that the market is seeking new levels. It is this breakout behavior that’s causes the system to enter a trade. On the other hand when the market has price stability, that the market condition is not good for trading.

Essential open code for breakout strategies are provided to TMT members monthly. In my plug in a trade arsenal of day traders Eclipsed III, KeenerEdge and New Turtle Trader are all breakout style traders.

Jack F. Cahn, CMT