When trading you have the choice of many different methods. The ones which stood the test of time is breakout trading. It is the method that worked best in the past and still generates very robust and profitable results. It is also the method we use for our trading. In this article you will learn:

  • how a breakout trading strategies look like,
  • its most important elements,
  • the results of a real example, and
  • for which markets they works best

Example Code

I would like to show you an example code to explain how a trading strategy may look like in its simplest form. The ones we use for real trading are a bit more complex, but not much more. Just to be clear, this is not a code that can be traded, but is used as an example only.

Example Breakout Trading Easylanguage Code

Such code consists of variable definition, calculations of POI, BO_Level and Setup (discussed below), the entry and the exit.

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Break-out Trading is the method that worked best in the past and still generates very robust and profitable results.

Oliver Haller, alphamonda

The Entry

First, we want to discuss the entry. This is what breakout trading is famous for. It consists of a setup and a trigger. The setup is a filter that analyzes the historic market conditions and calculates whether there is a high chance of a good trade. Only if the setup is very good, the strategy will be allowed to enter the market. There are many ways to create such a setup. They range from using straight technical analysis, e.g. moving averages, RSI or volatility filters, to more sophisticated analysis of volume, open interest, market internals, intermarket relationships or commitment of trader reports to name a few. Most of these are well know in the trading community. The trick is to know which one to use for which market.

If the setup is good then the breakout level can be defined. The strategy defines a Point of Initiation, this can be the last close, the highest high of the last days or similar mostly simple rules. It then determines how far the market has to move away from this Point of Initiation. We call this the Distance. It is typically calculated taking the volatility of the market into account. Thus, in a very volatile market environment the Distance will be large, in a calm and not so volatile market the Distance will be small.

The Breakout Level will then be determined by adding the Distance to the Point of Initiation. If the setup permits and the Breakout Level is crossed by the market price the strategy will issue a buy order (or a sell order if the Breakout Level is crossed from above).

Breakout Trading

The Position Sizing

Before the buy (or sell) order is issued, there is one more thing which needs to be done, we need to decide how many shares or contracts to trade. This will depend on the one hand on your trading capital, the risk you would like to take, and the position sizing method (fixed, fixed fractional, fixed ratio etc.). I will describe modern position sizing in another post. On the other hand, it will also be determined by the market. If the market environment is very good the strategy may decide to trade a larger number of shares or contracts then in a normal, but good set-up.

Now we are in the trade and hopefully watch the open equity grow. The question will be when to exit again.

The Exit

This is not specific for break-out strategies. You will need to decide when to take a profit. Again, there are many ways to do this. Our strategies use different types of exits, depending on the market and strategy type. They range from a simple end of day exit for day trading strategies to more complex exits which define profit targets based on the market type and overall conditions.

Certainly, strategies do not win all the time, so you also need to decide when to cut your losses. This is typically done with stop losses which are built into the strategy. They can be either fixed at a certain dollar value or depend also on the market conditions. Also, these stop losses have to be crafted so that they fit well to the market and strategy type.

How does a Real Breakout Trading Strategy Look Like?

I will not be able to give you the exact code of one of our real strategies, but show you the result. As said, the code will be similar to the one above, but more complex, better fitted to a specific market and most importantly robust. With robust I mean that it is tested to have a high likelihood to work also in the future.

Below you find the result of a typical Breakout Strategy. They come in two flavors. Either as a day trading or as a swing trading strategy. The one below is a swing trading strategy on a futures market (RB which is the eMini for the NYHarborBlendedstock RBOB).

Equity Curve with Live Data

What you can see is that it uses 15-minute bars. Thus, at the end of each bar it is calculating the set-up and then may issue a buy order (this one trades long only) which will be a stop order. This is not to be confused with the stop order that protects you from losses, but a stop order which includes the break-out level. Thus, only if the market price crosses above this level, the order will be filled.

As you can see from the performance report below. The strategy would have made $181k of Total Net Profit. I trade it since October 2018 which indicted with the blue line. (Disclaimer: The values before the blue line are a backtest, so results are hypothetical and may be different in the future). What is more important are Percent Profitable which is 59.31% and Ratio Avg. Win/Avg. Loss which is 1.14. For break-out strategies these numbers vary typically from 40% to 60% for the Percent Profitable parameter and from 1 to 3 for the Ratio Avg. Win/Avg. Loss.

Many traders will also look at the Profit Factor (here 1.66) and Drawdown (here $8,354.20). For break-out strategies these values vary typically between 1.2 and 2 for the Profit Factor. The drawdown should be seen in relation to the Total Net Profit. The factor Total Net Profit / Drawdown (Close to Close) will be around 10 for most cases. Do not expect miracles here, the show example is a very good strategy, not all perform that well.

Example Performance Report Break-out Strategy

Which Markets Work Best

We use Breakout Strategies to trade futures markets. These include eMinis (market indexes), but also energies, grains, currencies etc. The breakout trading works best for the first two, but we also trade other markets since at the end it is not the strategy that makes the difference, but the portfolio which benefits a lot from low correlated strategies.

What Comes Next

In this article I showed you in a very basic way the main components of a break-out strategy and real results from one of our swing trading strategies.

In future articles I plan to describe more in detail, the anatomy of day and swing trading strategies. Explain a bit more why algorithmic trading works and give some insights in how we develop them. In this article from Patrick Dütsch you can read how we use machine learning to speed up the development process. If there are any specific topics you would like to read about, just write me a mail or leave a comment below.