I love trading breakouts and piling into trends. Â As such I’ve been spending an awful lot of time trying to understand patterns that the assets make prior to breaking out and forming new trends.
It’s not rocket science, from a chart perspective breakouts happen when an asset hits a resistance line, then breaks through it, and continues higher. Â The resistance line is typically a 52 week or all time high, or some other “line” in the asset’s class price action based on some previous event in time.
Breakouts are also a function of news, such as fundamental changes in outlook of a particular asset. Â Perhaps Apple came out with a new product like the iPoop and this causes investors, funds, traders, etc to pile into or out of the stock. When they do, they leave clues in the price/volume action on charts.
Devoid of reading the news, the only way we can see changes in trader/investorÂ psychologyÂ is through these price and volume clues. Â This is why Â I’m a big on understand candlesticks. Â I like to look at charts and find where there are hammers, spinning tops, engulfing candles, and other “trend changing” formations.
However there is no way that, I as a human, can seeÂ subtleÂ changes in price/volume changes in stocks that may be hiding clues in market psychology, but a computer can. Â That’s where Rapidminer is helping me decipher these subtle clues and patterns.
Below is a chart of the ETF GWX. Â It broke out around September 13th, 2010 and seems to be trending higher. Â Ideally, a trend trader would probably get long above the August 6th spinning top and the resistance line around $26.40ish. Â Now wouldn’t it have been better to have gotten long sometime around August 24th?
The answer is YES but would a trader do so? NO! You’d be concerned that the price could drop and you’d wait for the bounce to follow through and might even make a small trade to ride it back up to the resistance line. Â However, once the resistance breaks, you can bet people will pile in (see the volume action in October).
So I’ve been working on a model to try and identify when a new trend, and a subsquent break of the resistance line, is going to happen. Â When will the odds be in my favor? What is the right time to establish a position before the masses do?
Well, it ain’t easy but I think I’m making progress. Â Take a look at the Rapidminer chart below:
The red line activity (my break out signal) coincides with the breakout of GWX (blue line)for the Sept 13th period. Â So the model is now identifying breakouts, which is progress in my book. Â However, the trick is for the model tell me to get long on August 24th, which it doesn’t do right now.