A breakout of a trading instrument refers to a time when the price of a trading instrument enters the top of a resistance area or the bottom of a support zone with a large volume. The more times the trading instrument has touched the resistance and support areas for a long period of time, the more reliability we can predict its breakout.
Breakouts are useful for traders to acknowledge due to the fact that they indicate important information, such as major price trends and swings or spikes in volatility, which can help a trader enter a long or short position accordingly.
For example, a trading instrument which is set to close above the resistance area will typically cause a trader to anticipate a bull market and take a long position. The opposite is also true, meaning that when a trading instrument is set to close below a line of support, a trader would anticipate a bear market and take a short position. If the price of the trading instrument is not accompanied by a significant volume, it would indicate a reluctance for the price to continue in that trajectory, and it could be possible for it to return back to the previous direction.
Since not all traders use the same levels of support and resistance in their analysis, the interpretation of the failure of these levels can be highly dependent on the personal opinion of each trader. Stop loss orders are a great contingency plan in case the breakout was not legitimate and the price returns to below the resistance area.
Breakout trading is favorable to traders because there is limited risk with stop loss orders, potential large profits with the ability to catch onto strong trends quickly, and the creation of an easy to manage trading plan.