This document discusses breakouts in financial markets. It defines a breakout as when a price breaks through a prior support or resistance level, indicating a change in supply and demand and a new price trend. It discusses various ways to confirm that a breakout is valid, including close filters, point or percentage filters, time filters, increased volume, and volatility measures like beta, standard deviation, and average true range. The document also explains how breakouts can sometimes be anticipated based on clues like increasing volume accompanying price oscillations below resistance or rising price lows with increased volume.

1. Lecture - 13
Breakouts
CMT LEVEL - I

2. CMT LEVEL - I
Learning Objectives
 Breakout & Its Basics
 Identification of Breakouts
 Confirmation of Breakouts
- Close Filter
- Point or Percent Filter
- Time
- Volume
- Volatility & Beta
- Standard Deviations
- Average True Range
- Pivot Points
 Signals predict Breakouts
 Anticipation of Breakouts

3. Breakouts
• A breakout occurs most often when a price “breaks out” through a
prior support or resistance level or zone.
• A significant change in supply and demand has occurred and that a
new price trend is beginning.
• For this reason alone, a breakout is an extremely important signal to
the investor or trader.
• Breakout in the direction of the previous trend is a confirmation that
the trend still exists, and a breakout in the opposite direction of a
previous trend suggests that the trend is reversing and that a
position should be closed and possibly reversed.
• Breakouts occur when prices pass through specific levels.

4. How Is Breakout Confirmed?
•The first requirement for a breakout is a penetration of
a trend line, or support or resistance zone.
•The next requirement is confirmation that the
penetration is a real breakout, not a false one (Volume
Participation Confirmation)
•When the exact breakout level is not clear, as in a
support or resistance zone, the extreme level of the
zone is considered the breakout level.
•A break of the lowest support point is evidence that
the entire support zone has been penetrated.

5. How Is Breakout Confirmed?

6. Close Filter
•The analyst's standpoint is that when the penetration is
occurring, there is usually no other confirming evidence
until after the close of trading.
•Some analysts will act immediately on the penetration and
wait for the confirmation later.
•If the price closes on the non breakout side of the breakout
level, it is plain that the intra-day penetration was likely
false and new lines might have to be drawn to account for
it.
•On the other hand, if the closing price is through the
breakout level, the odds are higher that the breakout is
real.

7. Close Filter

8. Point or Percent Filter
•Another confirmation method is to establish a breakout
zone either a certain number or fraction of points or a
percentage beyond the breakout level, where both a filter
and a close are required for a breakout.
• If the price can penetrate the breakout level and a
prescribed zone beyond it, the penetration must be real.
•The number of points or percentage is determined before
the penetration and is helpful in computerized models
where a definite breakout price needs to be established.

9. Point or Percent Filter

10. Time
•The basis is that if the penetration remains outside the
breakout zone for a certain time, it must be real.
• The usual time period is two bars, but it can be any length
of time.
•The price must remain beyond, or at least close beyond,
the breakout level for the required number of bars.
•A combination of the time rule and the close rule uses both
rules.
•This method requires a penetration and close beyond the
breakout level, and then a second bar in which the price
penetrates even further beyond the breakout level.

11. Volume
•Increased volume of trading often occurs with a
breakout.
•Heavier trading demonstrates that other market
players are acting in the direction of the new
trend and that there is sufficient power behind
the penetration.
•volume can dramatically decline on a breakout,
and the breakout is still valid.

12. Volatility
• A filter rule that uses some arbitrary point or
percentage rule is likely to be broken by a highly
volatile security before a true breakout occurs.
•In this case, analysts may consider the price volatility
of the security when determining what the filter for a
legitimate breakout should be.
•Three means of calculating volatility are most often
used; these are beta, standard deviation of price, and
average true range (ATR).

13. Beta
• Beta is a calculation of the volatility of a security
relative to a market proxy, usually the S&P 500.
•Beta's use has diminished over the years, as the
underlying assumption that it is a valid measure of risk
• It does have one advantage in that it eliminates the
trend of the market from the volatility calculation.

14. Standard deviation
• Standard deviation of returns, based on the
percentage change in price, is the basis for most
option and other derivative models and uses the
complete set of prices over some past period in time.
• Its usefulness as a breakout filter is diminished by the
fact that its value is influenced by the underlying trend
of the security.
•The breakout filter must use the volatility about the
trend and not include the trend itself.

15. Average True Range
• Average true range (ATR) is a derivation of the average
range, which is just the average of the difference between
each bar high and low over some past period.
•The ATR is an average of the true range of each bar
•ATR is an excellent measure of volatility and is used in
many indicators as well as breakout and stop-loss formulas.
•This means that a highly volatile security will have a wider
filter to reduce its likelihood of making a false breakout just
because of its higher volatility.

16. Average True Range

17. Pivot Point Technique
•The pivot point technique is a method of determining likely
support and resistance levels. It is widely used by day
traders to establish potential price ranges for the day and
rarely used as confirmation for breakouts
•This technique uses the previous period's high, low, and
close to establish support and resistance levels for the
current period.
•A series of points called pivot points for the current period
are calculated from price points derived from the previous
period.
•These calculations establish upper and lower levels at
which prices are expected to meet resistance or support
based on the previous period's action.

18. Pivot Point Technique

19. Can a Breakout Be Anticipated?
• Volume is a clue that a breakout is about to occur
• An increase in volume with a trend is supportive of
that trend.
•Thus, when prices are oscillating, for example, beneath
a resistance zone and volume increases on every small
up leg and decreases with every small down leg, the
odds favor that the price will eventually break up
through the resistance zone because the increased
volume expresses increased interest on the buy side.

20. Can a Breakout Be Anticipated?
•Prices can also give a hint as to their next directional move.
•If this tendency to have slightly rising lows is accompanied
by increasing volume on the rallies, the probability of an
upward breakout through resistance increases.
•Resistance has existed in the past and has stopped the first
price rally. A downward reversal takes place to the point
marked C. If volume increased on the initial rise to
resistance but declined on the correction to C, C becomes a
possible entry point in anticipation of a breakout above
resistance.

21. Can a Breakout Be Anticipated?