Ever missed an opportunity on a breakout…?

Hi readers,

We have been posting our views on stocks, sectors, and the market in general.

In this post, we introduce a trading concept – pullback after the breakout and how to benefit from it.

Ever had a feeling that you wanted to but didn’t get a ‘chance’ to get entry into a stock?

If yes, then read on…….

Some days back, we wrote on a stock – Pidilite Inds which was on the verge of a breakout.

The price recommended was 149 (to buy), but the stock opened itself at 152 the next day (A bullish GAP). If you entered a market order, you incur the costs of slippage. (A slippage is when the purchase price is more than the intended breakout price. Slippage cost eats into the profit potential)

So how does one react to such a situation, should one buy at the higher price, or let go the opportunity? Also if one has entered the limit order and left, there is no chance for him to enter whatsoever.

The concept of a pullback is of great importance in such a situation.

Once we decide a particular stock and the pattern to trade for it, the next thing we look for is the breakout price.

Watch the chart below

The triple bottom observed makes it a perfect pick for any technical analyst.

An entry is recommended usually on the neckline breakout about 148.

Watch the same chart a month later

The target was achieved but after a small pullback towards the neckline of the breakout.

The concept in discussion is this pullback. Historically, it has been observed that after a major breakout from a pattern or a trendline violation, there is a strong possibility of a retest of such a breakout. The prices rally back to the breakout point and then again rush towards the direction of the break.

(This finds a mention in the book Trading for a Living – Alexander Alder)

How does one benefit from this pullback?

1.      When one buys AT the breakout price, buy only half the quantity

2.      When a pullback happens, add the remainder at the tested price.

3.      If the pullback happens and prices confirm the retest, the signal becomes stronger as you have four more market participants on your side:

a.       People who wanted to buy but could not at the breakout

b.      Short traders who want to get out even

c.       Traders who never considered buying the stock (at all) – you are one of them if you had the ‘feeling’ described at the start. J

d.      Traders who sold out too early 

The following are some of the good recent examples of a retest of the breakout:

This works for people who short stocks too

Watch the retest in the following case in case of Shree Renuka sugars:

The volume game:

The following is to be noted in the pullback after breakout:

1.      Volume rises during the original breakout

2.      Volume falls at the retest of the breakout – confirming the pullback’s weak strength

3.      Volume rises with the successful retest confirming that the market participants want the breakout to continue.

4.      A different volume setup other than the above can be a warning of a false breakout: Note the next chart:

In Mid March, what appeared to be a trendline violation of Infosys, turned out to be a false breakout. The volume had decreased with the breakout, it increased at the retest of the breakout. The retest never happened. J

The stock is again below the trendline, but that is a different matter altogether now J

 So the next time, the breakout happens and you could not get IN, wait for a breakout.

Don’t unnecessarily increase the cost of purchase by putting a market order at the GAPPED price.

Even if the pullback doesn’t happen, it doesn’t matter as there will always be another opportunity in some other stock. J

Its worth waiting and observing….. rather than jumping to buy