You probably want to know about the strength of a breakout move before you decide if you are going to trade into that breakout or not. After all, the stronger the breakout, the more that you can potentially make off of it.
However, if that same breakout seems to be mild, you may want to wait for a little while before attempting to make a move in that market. It makes sense to wait until you have a little more confirmation and know for sure which way the market appears to be headed. You will benefit greatly from your patience if you can exhibit some.
There are two things that price can do after a period of consolidation:
- Continue in the same direction as before (continuation breakout)
- Reverse in the opposite direction (reversal breakout)
Either scenario could make you some money if you are willing to jump in and take advantage of the movements as they arrive, but you need to act quickly to make this a possibility at all.
Don’t you think it would be nice if you could confirm a breakout? Well, you can!
There are a couple of ways that you can confirm a breakout, and you need to know a bit about each of them so you know how to react when a breakout is taking place.
Moving Average Convergence/Divergence (MACD)
The MACD is one of the most commonly used indicators. It is easy to read, but it is also a dependable way to verify the momentum of a certain type of trade. In some cases, you may also need to verify the lack of momentum in a trade to get the true picture of what is going on.
Either way, you need to make sure you use your MACD indicator on a regular basis to understand the true dynamics at play in the market at any given time.
When the histogram on the MACD gets bigger, the momentum is stronger. When it gets smaller, the momentum is weaker.
When the momentum on the MACD is decreasing even as the trend is continuing, you can reasonably assume that the trend that has been playing out this whole time may be coming to a close.
Relative Strength Index (RSI)
The RSI indicator is another one that can be useful for determining reversal breakouts. This indicator will tell you the changes between the higher and lower closing prices over a given period of time.
It is used in a similar way to the MACD when looking for divergences and possible trend reversals.
When the RSI is above 70, you know that the market is overbought at that time. When it dips below 30, the market is oversold. You will see the RSI move into overbought or oversold territory depending on the direction of the trend and any possible reversal that may be happening at this time.
You should check to see if there is a divergence between the price movement and what the RSI is telling you if you feel that there is a reversal at play.