SPX Breakout – is this Finally It? Tips on Trading Breakouts

Sep 20, 2010: 9:36 AM CST

This morning, we’re getting a quick surge above the key 1,130 level and I wanted to do a quick update on that and focus on standard tips for trading breakouts – particularly in regard to confirmation and the question “Is this real or a trap?”

First, the Daily Chart so far:

The level is clear – 1,130.  We’re above that now – but look back to June where we “broke out” above the 50 EMA… only to collapse back to new lows in a hideous bull trap.  Treat each breakout individually.

Let’s now zip down to the 5-min current (morning) chart:

I’ve been saying for quite some time – as is the standard practice for breakouts – that ANY break above 1,130 is likely to trigger an initial surge of buying potentially FIRST from short-sellers who are trapped and being forced out via stop-losses.  That’s a Short-Squeeze.

The key is whether BUYERS will step in here to keep supporting this market higher, or if the BEARS are the one causing this surge.  If it’s the bears, we’re likely to collapse back in the range as this rally would “have no legs.”

If it’s the combination of bears BUYING to cover and then bulls/buyers genuinely BUYING the breakout, then we have a Positive Feedback Loop where higher prices force more bears to buy-to-cover, which draws in more bulls to buy, which draws even more bears to buy-to-cover, and so on.  That’s why breakouts can be so violent – like this one appears to be initially.  It’s what you should expect.

Treat each breakout individually – and here’s a few tips for this one:

1.  Aggressive traders will begin positioning now (either covering shorts or buying).  If this is a true breakout, aggressive traders want to position or reposition early.

2.  Conservative traders will need to WAIT FOR CONFIRMATION before positioning.

There are a few methods for identifying chart confirmation, but the most popular are waiting for a One-Day official CLOSE above 1,130, or even demanding that price close TWO days above 1,130 (before positioning).  That will reduce the chance of a whipsaw (getting caught the wrong way in what ultimately is a bull trap) but will cause a late entry… or exit if short.

Other methods include percentage functions (say, demanding that price move or close 2% above 1,130, which would be about 22 points, or an official trigger of 1,152.

Keep in mind there are two major factors (that I can think of) that affect this breakout:

1.  President Obama’s speech/town-hall later today at 12:00 EST.  A major announcement could send the market further rallying higher, or collapsing back under 1,130.  Most likely, he won’t say anything that hurts the market.

2.  The Federal Reserve Announcement at 2:15 EST Tuesday.

Again, a major announcement could send this breakout surging higher or collapsing lower.  Most likely, the Fed will announce something “bullish” such as a continuation of Quantitative Easing and isn’t expected to deliver any earth-shattering negative economic news.

If you’re an active trader, you’re likely participating in this move but if you have to make the “What do I do with a breakout of a few points?” question, you might want to apply one of the conservative “prove it to me” strategies above, or wait to see the market response from the Federal Reserve.

And it’s possible this initial breakout is in part due to traders/investors EXPECTING good news either from the President or from the Federal Reserve… or both.

We shall soon see for sure!

Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade

8 Comments

8 Responses to “SPX Breakout – is this Finally It? Tips on Trading Breakouts”

  1. Don-da-mon Says:

    I think the Fed Announcement might be “perceived” as the reason, or explained by the main media as “the reason” for a surge, however, it will still just be a short covering rally, regardless on what the fed “says” it will do.

    What news has really affected the markets lately? Seems fund managers are just keying off quarter and yearly comparisons. Wasn’t the flash crash just a change to going short by many fund managers? Hence, going higher than that is nearly impossible.

  2. arthur stowe Says:

    thx 4 covering this ground

  3. Pipsous Says:

    TLT is up for last 2 days. so bond market is not supporting this stock market moving higher.

  4. Boom N Bust Says:

    ” demanding that price move or close 1% above 1,130, which would be about 22 points, or an official trigger of 1,152. ”

    Is not 1% of 1130 11 points .. ?

  5. Corey Rosenbloom, CMT Says:

    I meant to type in 2% but somehow hit the 1 instead – the 2% rule is desired to the 1% rule. Thanks for letting me know!

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