How do you identify and avoid a Failed Breakout or getting caught in a Bull Trap?
Akamai Technologies (AKAM) – a strongly trending stock – offers a key lesson in this important topic.
Be sure to study Part 1 of the “Lessons We Can Learn from the Breakouts in AKAM.”
Failed breakouts or traps scare many traders away from trading valid breakouts, but what key factors often differentiate a successful breakout from a failed one (trap)?
Let’s highlight the 2014 period that saw three failed breakouts trap traders into frustration.
Could this have been avoided?
The chart above provides the perspective from the strong trend on the weekly chart.
Again, study the four successful breakouts from the prior post but focus your attention here on the traps.
We’ll zoom-in here on the Red Arrow, the period of failed breakouts throughout 2014.
AKAM’s chart teaches us what to look for if we take a breakout trade that is very likely to fail soon (trap).
Take the perspecitve and focus on the Red Arrow as we drop to the Daily Chart for clearer insights:
The Daily Chart above simply highlights the period in 2014 from the February gap through the three Bull Traps or Failed Breakouts that plagued traders.
The next chart simply zooms in closer on the $ 63 per share level, taking us past the earlier gap:
In June, buyers pushed against this level but failed to generate a breakout – no breakout means no trade.
However, a second attempt in September DID generate the first breakout above this level.
Traders who rushed in logically to buy the breakout above $ 63 were immediately hit with a vicious reversal day (big red candle) which sprung a trap and collapsed the price all the way back to the $ 52.00 per share low, creating instant losses for the bulls.
Again, could this have been avoided?
After cleaning their wounds, bulls (buyers) regrouped and thrust the price back to the key resistance level but this time they were successful… temporarily.
Two breakouts – two traps in December.
What factors could have highlighted that the breakout was more likely to fail than to succeed?
Pay close attention to the yellow highlights connecting these breakouts to Volume and Momentum.
In all three examples, Volume declined as price rallied as did the 3/10 Momentum Oscillator.
We can find a pattern in these three breakouts:
Each was met after the breakout with a reduction in Volume and Momentum. Divergences preceded the reversal.
To see this concept much clearer, let’s focus on #2 and #3 (failed breakouts) on the Intraday Frame:
Assume you bought in both examples simply because price broke (and gapped) above the $ 63.50 key level.
That’s a great trading strategy to join a bullish trend in a strong stock expected to get stronger.
However, as price broke higher – both times toward $ 65.00 per share – look closely at Volume and Momentum.
Instead of strengthening with price – confirmation – both indicators clearly declined as the price went higher.
Obvious divergences on the chart often precede failed breakouts or upcoming “Traps” (reversals).
November saw a bullish breakout only to see Volume and Momentum decline. Price gapped lower and then collapsed upon one more failed attempt to hold above $ 63.50.
Similarly, buyers thrust the market back above $ 63.50 in December… only to see an identical outcome (trap).
Both events featured a clear multi-day divergence situation as a Bull Trap zapped the profits of those who bought.
If you’re in a Bullish Breakout position and volume/momentum clearly decline, EXIT THE POSITION.
Finally, let’s see what a true, valid, profitable, efficient Breakout looks like in comparison:
I included example #3 in December to compare it with February’s successful breakout and rally.
Volume surged and stayed strong on the gap-breakout above $ 63.50 per share.
Momentum strengthened initially on the breakout then GOT EVEN STRONGER (made a new high) as the upside action expanded.
When you join price on a breakout AND you see volume/momentum strengthen, aim to hold the position confidently as long as possible to capture profits from a one-sided breakout price action.
If instead you join a breakout yet price/volume decline, signaling non-confirmation, exit first and ask questions later.
Follow along with members of the Daily Commentary and Idealized Trades summaries for real-time updates and additional trade planning.
Corey Rosenbloom, CMT
Afraid to Trade.com
Follow Corey on Twitter: http://twitter.com/afraidtotrade