Breakout Model System

[Leth]

Breakout Model
by Stan Weinstein

Stan Weinstein, in Secrets for Profiting in Bull and Bear Markets, provides one of the most complete models for trading long-term trends. The model employs a combination of proven techniques to identify breakouts from a trading range, to follow the progress of a trend and to identify appropriate exit points. It is important to read the book to understand the full model which is briefly summarized below.

Trading Ranges

market%20phases.png

The long-term cycle has four distinct stages:

-stage 1 and 3 being trading ranges or reversal patterns; and
-stage 2 and 4 being trends.

1. Base or Bottom
The market ranges between support and resistance, after a stage 4 down-trend. The index normally whipsaws around long-term moving averages and there may be clear signs of accumulation, including declining volume on downward movements and increasing volume on rallies.
2. Primary up-trend
Stage 2 up-trends follow a breakout from stage 1. The index respects long-term moving averages (from above) and there should be strong volume on rallies and light volume on corrections.
3. Top
The market levels off into a trading range after a stage 2 up-trend. The index normally whipsaws around long-term moving averages, with greater volatility than stage 1. A stage 3 top normally continues to show high volume as the market repeatedly attempts to overcome resistance. A dry-up of volume may signal that the trading range will breakout on the upside, reverting back to a stage 2 up-trend.
4. Primary down-trend
A stage 4 down-trend follows a break below a stage 3 top. The index respects long-term moving averages (from below), with strong volume on declines and light volume on upward corrections.
Sometimes the market forms a chart pattern, such as a descending or ascending triangle, in place of a rectangular trading range in stages 1 or 3.

The stages are not always as easy to identify as in the above illustration: a trend may last more than a year and a reversal pattern may be over within a week. Up-trends (or down-trends) may also be interrupted by a trading range before continuing the trend.

The model uses moving averages; trendlines; and breakouts above resistance levels to identify the start of a new trend.

30-Week Moving Average

No trades may be entered if price is below the 30-week weighted moving average or if the moving average slopes downwards.

Volume Confirmation

Breakouts must be confirmed by higher than usual volume activity.

Trailing Sell-Stops

Stop loss orders are moved up to below the Low of each successively higher trough in the up-trend or the 30-week MA, whichever is the lower. See Adjusting Stop Levels for details.

If the 30-week MA starts to level out and it appears that the stock is entering a Phase 3 top, then the stops are moved up to below the bottom of each successive trough and the 30-week MA is ignored.

Exit

Trailing sell-stops account for most of the exits from the trend. Exit immediately, however, if price falls below the 30-week MA and the MA is no longer rising.

Example

Yahoo is shown with Blue 30-week weighted moving average.

yhoo%2030weekma.png

1. Price breaks above the $3.00 resistance level [R] in June 1997. This is followed by a correction before a second breakout above the resistance which is confirmed by large volume. The entry point is marked by [E] and the 30-week MA is rising strongly.
2. Stops (depicted by trendlines below the MA) are adjusted upwards as the trend progresses, but never above the 30-week MA as long as it is rising.
3. Price crosses below the MA at [?] but the position is not closed as the MA is still rising.
4. The position is stopped out at [X] when price falls below the previous stop level set just below $60.00.