Patience is the key when trading a breakout

Question

Dear Ms.Coulling,
I’m a reader of A Complete Guide to Volume Price Analysis from China. I’m writing the letter right after I finished the book to show my thanks. This is truly a great book for a new hand like me to understand basic of trading. I noticed at the end of the book, you mentioned you might update the book in future. Then I would like to discuss some subject which I believe readers may be interested, however I didn’t get clear explanations in the book, so that you could incorporate in next update, if suitable, to make the book perfect.

I would like to make a brief self-introduction first. I started trading in 2008, which was not a good year for most of the traders and investors. It was not good for me as well. But sometimes I feel it was not that bad. Sooner or later will the loss experience come. The crisis did educated me and influented on my trading methodology. I believe trading is all about risk control and loss management.  Before I considered to be a full-time trader, I traded and then stopped, and traded again some other day. I picked up my limited knowledge about trading mostly from articles on webs. Your book is the second book I have read on trading. And it is the first one I selected to read when I decided to become a full-time trader.

The subjects I would like to discuss is the buy opportunity in congestion phase.  When breakout comes and validated by volumes, a new trend is on the way. And it is a buy when insider starts to test right after the break out. Above is my understanding after reading. I have some puzzles.

First, if I don’t have position when price is in congestion phase. Should I wait for a validated breakout or enter before it? A breakout is usually a wide spread candle which means a lot of profit. If I enter early, then I think I’m in an advantageous position. Obviously I will not miss the profit on the breakout candle, no matter it’s a validated breakout or a fake one. I could hold the profit first. If it’s validated by volume, I hold position, while if it’s a fake one with below average volume I sell and take the profit. However entering before a validated breakout means I have to take the risk that the breakout may go against my position.  This dilemma is very common for a Pennant Flag pattern. Should I enter when price swings into a narrow angle before the breakout?

Second, if I already have a position when price is in congestion, should I hold and wait for breakout? This dilemma always comes with ceiling and floor congestion. Since the congestion phase could last for weeks or even months, holding may only cost time and result in breakout against position.

I wonder if there is a perfect solution for the issue. Now I deal with the issue by entering right before breakout with light position and stopping loss if price breakout against position. Of course if I want to make money. I have to  guarantee my judgement more 50% right at least. I’m not sure my solution is good or not. I hope you could explain more on this subject.

The other subject I hope your could include in your book, or maybe a new one is how to select trading instrument, especially in stock market. Actually I only have experience in stock market. Every time I thought I screen an active stock, I only result in finding my position in mud. I think this is an interesting subject, which has been explained by some books. I would be very happy if you could lay out from your perspective.

Answer

Hi Yang Lee

Many thanks for you email and for buying my book which is much appreciated. Also thank you so much for your very kind and generous words. I am most touched and delighted you have enjoyed the book. Also may I compliment on your English, which is perfect and easy to understand.

Now I will try and answer the question and comments you make in your mail which center around the whole issue of congestion phases of price action and break outs. So let me try to clarify this for you.

First of all congestion phases are the most important areas of price action on a chart and in all time frames as they are the point at which new trends develop, or existing trends continue. As a rule of thumb the longer the congestion phase then the greater the extent of any future trend is likely to run as these are the regions in which the market insiders and specialists are accumulating or distributing in preparation for the next move.

The key to trading a breakout is patience, and herein lies the problem, which you highlighted in your email. It is all too easy to see the price action start to move away, perhaps building a wide candle (either to the upside or the downside) and to jump on board before the candle has completed. This is triggered by the fear of missing out on a move, and being left behind. However, it is imperative to wait until the candle closes and that the price action is validated by volume as it is all too easy for the insiders to move the price sharply away from the congestion, only to reverse it in the same candle and back again into the congestion. I fully accept that this requires giving up some potential profit, but if you are trading on the breakout then you would not be looking for a profitable position from one candle, but for a longer term development of the trend, over several bars, regardless of whether you are trading minutes, hours or days.

With regard to your second point of holding through a congestion phase the answer is, it depends on what you are seeing in terms of volume price analysis reflected in other time frames. For example if you are long and the market has moved into congestion on your trading time frame you need to check to see what is happening on your dominant (or higher) time frame. Do you see signs of weakness in a slower time frame? This may be sending a strong signal that the congestion is not merely a pause, but a prelude to a
reversal, and therefore potentially time to exit.

As always in trading there is no perfect answer or simple solution, but the beauty of using volume price analysis is, not only will it tell you when to get into the market, but it will also alert you to exit. It’s a constant process of analysis across multiple time frames, using volume, price, candles, candle patterns, and of course, support and resistance.

In addition, when trading a breakout from congestion please remember that these regions of price action are natural barriers for the market and therefore ideal places for any initial stop loss. So, for example, if the market breaks to the upside position your stop loss close to the underside of the floor of congestion. And if it breaks to the downside any stop loss should be above the ceiling of congestion. 

Finally, with regard to stock trading, I am writing a major stock trading book which will be available early next year, but in the meantime please apply exactly the same volume price techniques that I explain in the book to selecting and trading stocks. The process is identical and again a further advantage of this methodology. Once learnt, you can apply it to any market or instrument, provided volume is reported, cash, futures or otherwise.

I hope the above helps & many thanks again for taking the time and trouble
to write to me – kind regards.

About Anna 1027 Articles
Hi – my name is Anna Coulling and I am a full time currency, commodities and equities trader. I have been involved in both trading and investing for over fifteen years and have traded many different financial instruments, from options and futures to stocks and commodities. I write and publish articles ( mostly for free ) for UK and international publications on a wide variety of financial issues, and in particular I enjoy helping others learn how to invest and trade.

2 Comments on Patience is the key when trading a breakout

  1. Ms Coulling, now I having a little problem installing the classic volume indicator on my platform ( probably me
    is there any other indicator I can use for a while until I can solve this issue. thanks!

    • Hi Fred – many thanks for contacting me – please can you advise what platform you are using and happy to help if I can – all best wishes Anna

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