Semiconductors give us a near-perfect breakout
For the past several weeks, we have been trading the Semiconductor Sector (SOXX). During that time, it has steadily built a Bullish Ascending Triangle structure.
This Price Structure has handed the Strategic Trading Community three easy long and short trades in October alone, as it bounced between Support and Resistance.
And for the past two weeks, SOXX had been telling us that it was ready to break out.
This potential breakout looked promising… and more so because we were flush with profits (and confidence) after three big successful SOXX swing trades in recent weeks.
So we watched the SOXX chart and waited for our signal.
Well, we didn’t have to wait long.
On October 25th, we finally got our breakout, as SOXX bulldozed through our breakout level at 220.80, closing the week at 223.70.
Because we had anticipated this breakout, we were well-prepared for it… but at the last moment, I decided that “SOXX had moved too far up, too quickly.”
In other words, SOXX suddenly looked a bit too wild… even though it was behaving exactly as we expected.
Market psychology is a funny thing, isn’t it?
So I decided to wait for a backtest of the breakout… just to be safe! Aren't I smart? (yes, yes... go ahead and laugh!)
But before we continue, let’s talk about what a backtest actually is.
During a backtest, a breakout move will suddenly pause... as prices pull back to their key breakout level (in this case, 220.80).
This backtest gets its name from the fact that the market likes to test the resolve of buyers… and see if there is real, enduring demand before continuing the breakout move.
Backtests happen approximately half the time in the stock market.
During normal markets, they happen almost all the time.
During strong bull markets, though, we see far fewer backtests after a price breakout.
Well, it looks like we’re in a strong bull market right now (to point out the obvious).
So... back to our SOXX story.
On Thursday, October 31st, it looked like the backtest was finally happening, and SOXX pulled back sharply.
As SOXX approached the 220.80 breakout level, buyers came in before prices could reach 220.80… causing SOXX to fly towards the sky, without looking back.
If we look at the SOXX Weekly Chart, we can see the “near-backtest” more clearly.
Weekly charts are often the best charts to use when we’re looking for a clear picture with a minimum of noise.
For now, it looks like the SOXX Breakout is a success.
Prices are now in the midst of a 11% - 15% breakout rally, with a measured move target near $241 - $248 (depending on how quickly the rally happens… a faster rally often exhausts itself at a lower price).
So what is the point of all this? Is there something we can learn?
There are several valuable lessons here… which we can use to improve our performance next time (and there will always be a next time… the market is overflowing with opportunities).
When we are trading breakouts, it’s hugely important to know the market’s overall health… and in particular, how much liquidity there is in the market.
A strong market with abundant liquidity will often succeed in its breakouts, because investors have fewer reasons to sell their stocks… They already have plenty of cash.
When a market weakens and liquidity dries up, breakouts will fail much more often as sellers use any opportunity to raise cash… and new buyers find themselves unable to manage leveraged positions.
Liquidity is the key to understanding how the market will behave after a big breakout.
Recently, liquidity has been strong... and so market conditions have been favorable. The smart move here was to simply buy, and manage risk by scaling in with smaller positions.
Here's how we can scale into a breakout trade at reduced risk
Whenever a Price Structure breaks out, I often choose from one of four entry points, based on market conditions.
Entry Point A: Immediately enter when the market closes above our breakout (Flag) level, without waiting. This is the aggressive approach, for the strongest markets.
Entry Point B: If the market closes above our breakout level, we wait for a 38.2% to 50% retracement of the breakout before buying. Doing so improves our position’s upside and reduces its downside risk.
Entry Point C: If the market closes above the breakout level, wait for price to backtest the breakout (pullback to the Flag level). This is often the best overall method of entering breakout trades… but the risk is we might miss out on an entry if the market doesn’t backtest the breakout. That’s the decision we make.
Entry Point D: Enter in the middle of the Price Structure, under the breakout level but above our loss line (the bottom of the Price Structure, where our stop is). This is the safest way to enter a breakout trade, but will rarely ever trigger in a strong market. This approach is best saved for a weak market.
Here is a chart that shows our SOXX breakout trade, with the four entry points marked.
I chose to wait for Entry Point C… but the correct choice was actually Entry Point B (SOXX retraced just over 50% of its breakout, but didn’t pull back all the way to the breakout level).
Another approach might have been to enter half the position at Entry Point A, and half at Entry Point C… therefore removing any possibility of missing out, while keeping our risk reasonably low.
Some of our more aggressive members at Strategic Trading actually took Entry Point A… these brave souls are now sitting on some tidy profits (with more to come, if the pattern continues).
For my part, I’m happy with the profits we made in October on our three SOXX trades… and will be ready the next time this ETF delivers another easy trading opportunity.
I expect we won’t have to wait long for our next big trade in SOXX.
Patience will pay off.
Victory Loves Preparation.
The MCI Algorithm gave us an early signal that markets across the world were about to become bullish…
back when the S&P was still languishing near its October lows.
Here is the simple truth:
Liquidity and Money Flows are the key drivers of stock market prices.
Once we understand that, we gain an overwhelming advantage over other traders.
Strategic Trading members are enjoying direct access to the MCI Algorithm’s charts… with fresh signals every evening.
Armed with these charts, our members can see hidden changes in the market… before most other traders even realize what’s happening.
To join our community of winners, click here now.
Empower yourself, and start seeing the market more clearly than ever before.
