Many traders are familiar with the term “break out stock”, often stocks that are not well known and hit a perfect point in a chart for a breakout, and can then rise 30 to 200% in a short time.
Many traders are familiar with Investors Business Daily (IBD) and William O’Neill’s famous How to Make Money in Stocks. In fact, we recommend this book for its excellent study of cup and handle charting, and “springboarding” off break out pivot points , which has many similarities.
In my many years of trading I’ve heard great success stories on the wild rides up with breakout stocks, again typically not companies known well, and in the “exposure” stage.
O’Neil teaches a CANSLIM approach to trading stocks, using all the core rules and fundamentals to help a student trader know the basics about the potential growth for the stock.
Within this approach is a very tight stop loss. Breakout traders need to be buying at the pivot, with knowledge the pivot, based on increasing volume and “exposure” of the stock, will lead the stock up, with perhaps a short test, but without exposure of loss greater than 8%.
This means these type of traders are buying for breakout, and immediately sell if the stock falls 8%.
The logic of stop loss is critical. It should be set up for each stock. At Blue Chip Options we always use a X% trailing stop loss, meaning whatever % we will use (15, 20, or 25%) trailing the stock as it moves up, so that we are not taking a stop loss on a % for our buy basis, but our current value.
The positives to tight stop loss used in breakout stocks in today’s market is that it can occur in a day. In an hour. A trader can miss a move in the market, not the stock, and the emotions of the market carry 95% of the stocks down.
A simple rule: analyze how many 8% losses you are having. Prepare to study the return on investment (ROI) on if these losses exceed the gains. They often do.
And what I consider a core rule to breakout trading; Always sell in 1/3’s.
Sell 1/3 of your position at 20% profits, the second at 50% and let the rest the position run.
You will find at Blue Chip that we will see a random stock that has high volume on options, that we’ll play, as a breakout, risking with the option play just how much we were willing to lose with the 8%.
This is one of my most important rules:
Say the stock you want to buy is 35.00 a share and you will buy 500 shares. This equals 17,500 you are willing to invest to the stock.
We’ll invest an 8 to 10%, what we would use as stop loss, or up to $1750.00 in an option, willing to lose everything (as we would if it were and would if taking such a stop loss on our investment.) It is the same amount of money willing to be lost, with greater gain potential on the option.
