• Entering the day after a breakout

    This was originally a post made on the stock selection forum. However, the post was too long and the editor erased images. I therefore upgraded the post to "Article", which I placed in the "comment of the week" section. I will relocate this article later in the Breakout Calculator section.


    I have received a question about WWAV on how we could use the Breakout Calculator to find the best entry price for a long trade.

    WWAV has been in an uptrend since its IPO in October 2012.

    The stock broke out last Friday.

    As we can see below, the volume was higher than the highest negative volume of the past 10 up days, which qualifies the Breakout as a Breakout on Volume (BOV)

    After a breakout, there are four possibilities:

    1. Buy a pull-back to the 5MA or to the base of the breakout ($44.15 for us)
    2. Short the stock because exuberance buying acts like a rubber band which means that the price might naturally fall back down
    3. Buy higher in the top section of the envelope, with the hope of a continuation of the uptrend.
    4. Do nothing because the stock is too high

    Let's review the different possibilities. We will use an analysis period of 500 days, which is about the number of trading days since the IPO. So, we analyse the whole uptrend.

    1. Buy a pull-back to the 5MA or to the base of the breakout

    To test a pull-back to the 5MA, we only need to:
    A. Set the distance from the 5MA at 0% (Yellow cell)
    B. Set the number of days at 500 (Blue cell)
    C. Leave empty the two cells related to the stop level (Pink cells)

    As a reminder, when the stop cells are left empty, the BC will place the stop just outside of the envelope.

    We click "calculate" and the results are show below. These are acceptable results, almost good.

    Let's now use the sensitivity analysis function.
    As a reminder, the sensitivity analysis tests different entry prices within the envelope, by using the same stop level in percentage terms.
    We can see that the results are either Blue or Red colored. This is not the type of trade that is interesting. Usually, the R/R should be higher than 2.

    We can also note that a pullback to the base of the breakout at 44.15 offers a R/R between 1.28 and 1.4. This is clearly not a good trade to be entering.

    It seems strange that pullbacks have not produced interesting entries for the past 500 days, although the stock has been in a strong uptrend. This tends to tell us that this stock falls in the "breakout stock" type. This is a stock that would move up on a breakout, then run for days it the upper section of its envelope and finally settle down, before a new breakout.

    The most interesting point about the above table is that for WWAV, even pullbacks down to the bottom of the envelope cannot be bought. Why? Because usually, the price falls even lower.

    Even though it is not one of our hypothesis, let's briefly try to see if the stock responds well to oversold situations.
    As a reminder, the difference between a pullback and an oversold test is the long term average (for us the 50MA). A pullback will avoid long trades below the 50MA, while an oversold test will take all the trades, even when the price is below the 50MA.

    To test an oversold situation, we type OS in the "trade type" cell. I used -3% as a distance below the 5MA and kept the stop fixed at the previous level of 3.4%.

    The results shown below are not very interesting. We can also see that the probability to reach the entry price tomorrow is less than 1%, which means that is is only a theoretical exercise. If we ever reach that price at the next trading day, this would be very negative for the stock. So, that will not happen.

    Let's however run the sensitivity analysis for this stock in OS mode.

    As a reminder, when in an oversold type of trade test, the sensitivity analysis will try trades that are much deeper below the envelope.

    We can see in the table below that the stock responds well to very deep oversold situations.
    This is good to know for the future.

    2. Short the stock

    To test a short trade on a bounce, you simply need to type the entry level (3% above the 5MA), leave the stop cells empty, then type "Short" and "Bounce"

    The results shown below are not acceptable.

    The next trial is to replace the "Bounce" trade type by "OB" for Overbought.
    We clear the stops and relaunch the calculations. Results are still not acceptable

    The final step is to use the sensitivity analysis. We can see below that everything is Red. Hence, shorting even the most extended prices does not work with this stock.

    3. Buy higher in the top section of the envelope

    Below is something that I did not explain in the Pyramid book. When you want to enter a stock on a day after a breakout, it is essential to run the test on the breakout day, in order to see how the stock has reacted to past breakouts.

    Hence, we first need to erase the first line of data. That corresponds to March 27, since the breakout occurred on March 26.

    Make sure to erase online cells "A2:N2" and pull the rest of the file higher. If you erase the whole line, the calculations will be incorrect and you will probably get a fatal error.

    You then need to use BOV (Breakout on volume) as type of trade.
    For the stop level, In case of a breakout, I use to set the stop just below the 5MA. Since the 5MA was 43.1 on 3/26, I set the stop at 43. It is very rare for a breakout to pullback down below the 5MA.

    When you launch the calculation, the BC will ask your breakout price. I like the breakout to occur at a price higher than the previous day's high.

    The results are shown below. These are not encouraging.

    However, when running the sensitivity analysis, we can see that some green cells start to appear.
    This is very interesting, because these cells indicate that the strongest breakouts have better chances of offering good trading opportunities for this stock.

    Now, we can make a rational decision about buying a pullback after the breakout. Indeed, only breakouts that occurred 6% higher than the 5MA offered good trading opportunities in the past.

    With the red arrow, I show the closing price for the breakout day. This price is not in the green zone, indicating that the breakout was of the LOW QUALITY type. Hence, the decision here is to NOT buy even a pullback.

    I understand that this is a long post, but this I believe is the type of work you need to perform when you want to trade individual stocks. You need to understand how the shareholders of the stock act, because they will continue acting the same way in the future. I also believe that the Breakout Calculator is the only software available for free than can perform such an analysis.

    Trading is basically a zero sum game. You need to outwit the competition. The Breakout Calculator is in fact giving you a statistical view at how your competitors have been acting in the past.

    On the other hand, the Effective Volume Real-Time tools tell you what they are doing "right now". Their combination offers efficient weapons to beat the markets.