Trading the range breakout
As soon as the stock moves beyond its previously established range, traders act fast in buying it with good volume. Though this fulfils one of the requirements for a successful breakout trade, there is no guarantee that momentum will be sustained. To limit risk, it is advised to put in place a stoploss for such trades.
As an example, let’s suppose that stock prices are bouncing between Rs.128 and Rs.165. When it bursts beyond Rs.165 and rises to Rs.170, traders should go long on 170 and set a stop loss at Rs.165.
Alternatively, if the stock breaks out at Rs.128 (also referred to as the breakdown), and the trader goes short at Rs.123, they should use Rs.128 as their stoploss level.
Once the trade is initiated, if the breakout is genuine, the trader can anticipate a move in the stock that corresponds to the range’s width. For instance, after breaking out at Rs.168, we would expect at least 43 points of movement, as this is the width between 168 – 125. Thus, resulting in a price target of Rs.211.
The Flag formation
Flags are typically observed after a strong rally in stock prices and can be identified by two parallel lines. These chart formations, taking the shape of a parallelogram or rectangular flag, often appear on a pole and last for around 5-15 trading sessions.
With the two events of an upturn followed by a downturn, a flag formation is created. Subsequently, one can expect the stock to spike and then rise consistently up again.
For a trader who has missed the opportunity to purchase the stock, the flag formation presents a second chance. He must be quick, however, as the stock tends to skyrocket rapidly. This is notably visible in the chart above.
The reasoning for the flag pattern is relatively simple. Retail traders, content with the stock’s recent performance, begin to cash out, causing a drop in its value. Since only retail traders are selling off, volumes remain low.
On the other hand, investors with an eye for detail still have confidence in the stock, and consequently, the sentiment is optimistic. Subsequently, many traders see this as an opportunity to acquire the stock and the price shoots up unexpectedly.