Breakout or breakdown? How to identify and analyse these chart patterns

Breakout and breakdown are two distinct aspects of technical analysis. Breakout means a bullish up move and breakdown suggests a negative (downside) move. Both have their own significance in a trading setup, and hence, various strategies are developed to understand the breakout and breakdown patterns in the stock market.

 

A breakout indicates an up move that conquers the resistance/ neckline/ selling pressure of assets. The prices surpass the pressure area with an increase in volumes and the strength that triggers a fresh move with sentiment building in favour of the upward direction.

 

Breakdown, meanwhile, refers to a decline in price after falling below crucial support, weak buying momentum, and reversal levels. This scenario reflects the change in sentiment towards a bearish outlook with market participants looking to furiously sell their holdings. It is a negative phase wherein the prices are expected to decline in the near future.

 

How to identify breakout and breakdown

 

-- Volume needs to show significant improvement to impact the market sentiment.

 

-- After a breakout / breakdown, the price needs to show momentum. Volatility may yield false results, it is the price that needs to continue the same momentum on the breakout/ breakdown.

 

-- One also needs to focus on the follow-up buying/ selling

 

-- A strong breakout / breakdown needs to have a long body candle. This represents a definite confirmation.

 

-- The candle needs to close above the resistance in breakdown and below the support in the breakdown scenario.

 

Significance of Breakout and Breakdown

 

A clear identification of a breakout/ breakdown can provide high returns with the probability of making consistent gains. The move is usually furious and may even provide quick returns in a short span of time.

 

Low-risk bets are considered favourable in the breakout/ breakdown strategy. The risk-return ratio is actually twice–thrice high. As a result, one can expect higher returns on minimum risk. This is also the reason why maximum traders and investors prefer to trade breakout and breakdown. Moreover, having the sentiment of maximum market players on your side helps build a safer strategy and also boosts trading morale.

 

Understanding breakout and breakdown assists in taking well-informed decisions. One can also exit from unprofitable or highly risky trades as identifying such moves helps one liquidate over-leveraged positions. A major breakout/breakdown move on a bigger time frame can alter the overall sentiment to a great extent.

 

The various technical indicators that contribute to the breakout / breakdown are Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), Stochastic, Bollinger Band, Moving average, Parabolic SAR, candlestick pattern, etc. They all provide relevant signals to determine the breakout/ breakdown scenario. However, the combination of these indicators gives the most reliable confirmation. ( Glenmark Pharmaceuticals Chart)