A breakout occurs when the price of an asset exceeds a resistance or support level, thereby increasing trading volumes and volatility.
Breakouts may follow periods of low volatility, when there has been stationary price behaviour, i.e. when the value of the security moves within the limits imposed by support and resistance.
In general, the longer the price ‘bounces’ between these levels, i.e. remains in the ranging phase, the stronger the impact of an eventual breakout could be.
Depending on the price trend following the breakout, we can be faced with two possibilities:
- Continuation breakout: price respects the direction of the breakout, upwards for resistances and downwards for supports, without undergoing any reversal;
- Reversal breakout: the price trend that triggered the breakout does not continue, rather the trend undergoes a reversal. In this case, the breakout may evolve into a Bull Trap or a Bear Trap.
If the price of the asset, immediately after ‘breaking’ support or resistance, returns to the previous level, this is called a false breakout (or fakeout). This short breakout could mislead investors into buying or selling, and potentially cause losses.
In fact, traders pay particular attention to breakouts, trying to predict the price movements that might follow.
To anticipate a ‘breakout’ it is useful to use technical analysis tools, so as to at least identify the support or resistance involved; however, breakouts could only occur if accompanied by adequate trading volumes, but this is not a sufficient condition to determine them.