We know that trading breakouts during a bull market, increases our chances of catching big stock trends. Understanding how to use market confirmation will help you gain precision in trading breakouts. This is a concept that is neglected greatly in the world of trend trading. By understanding the correlation of markets and individual stocks, you can be in the market at the right time. The basic premise of market confirmation is that market sector, comparable stocks, and stock market indexes are ALL BULLISH if you were to take a long position on a stock or other financial instrument.
Example: If you want to buy Google stock. It would be wise to observe price action in other search engine stocks like SOHU, BIDU. You will also want to check the Nasdaq index for signs of bullish action. You would use techinical analysis like the moving averages and price patterns to confirm this.
Example Trade Using Bull Market Confirmation
On December 22, 2010 Arm Holdings chip maker for the Apple iphone, broke out of a cup and handle pattern on a significant rise in volume. This was an alert to buy the stock as it was making new highs. However, we also want to make sure that we have MARKET CONFIRMATION. In other words, is there congruency in the market action or is this a fake out. In order to increase the probability that a major trend will develop, we look for confirmation is related stocks, and the stock index or exchange in which the stocks are being traded.
So we know that ARMH is a chip maker for AAPL, it would be wise to observe the market action in Apple’s stock. We also know that both ARMH and AAPL are traded on the NASDAQ exchange. Observe the Charts Below:
We can see in the stock chart below, that ARMH traded above the breakout level forming a cup and handle pattern on December 22, 2010 , this is a buy signal. You would have also received a breakout signal for APPLE as well as the chart shows below. You must remember that when getting multiple breakouts, you must choose ONLY one stock, and the most powerful stock to trade. In this case, ARMH wins. on the breakout day, ARMH showed a larger percentage gain than AAPL.
Compare Stock vs Index For Confirmation
We see in the chart above AAPL broke out of a Double Bottom pattern making new highs on December 22, 2010 as well. This is CONFIRMATION that the tech sector is moving at once, this is when the most powerful and large trends are born. It’s a very bullish sign that the trend in both ARM will follow through. As you can see that, the ARM trend ended up developing into a more powerful and robust trend during this market run. Apple’s trend was a little choppy and you might have been stopped out prematurely. We know to take the trade in ARMH instead of AAPL this time around because on the DAY OF THE BREAKOUT, ARM Holdings showed more strength in price action. The percentage change in price action was larger than Apple’s.
In the chart above we are looking at the Nasdaq Index, where both ARMH and AAPL are traded on the Nasdaq exchange. Nasdaq stocks are mostly technology stocks and we can also consider looking at the Nasdaq the same as looking at the technology sector. On December 22nd the Nasdaq is making new highs and following through on the breakout that happened a couple of weeks ago. A very bullish sign.
The moving averages are also in bullish mode. 50day EMA (green line) is above the 200 day EMA (red line) and the 10 day EMA is above all the others. All bullish. Also note that the Trend is up. If we were to draw trend lines on this chart it would all be pointing upward toward higher prices.
Market Confirmation is important when trend trading and entering on the breakout. This increases the chance that the trend will not fail. Many traders complain that BREAKOUTS fail. This is because they forget to see if all indications are green. The whole concept of market confirmation is to make sure that you are “swimming with the current” not against it.
Once you have MARKET CONFIRMATION can now execute the trade to buy the breakout.
Recap Of Trading Strategy
-When trading the breakout compare markets, indexes, and similar stocks in the same industry or sector
-Theory: Markets correlate when in a trend.
-If trading Silver, for example, you may want to also take a look at Gold, Palladium and a Precious metal ETF like GLTR. You also might want to look at mining companies etc.
-Ask your self if these markets are bullish, observe trend lines, moving averages, and breakout patterns.