Thread by @SafdarAlam

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What happens in a "breakout" during trading activity?

One of the best trading opportunities in trading is to identify a break out and take a position (long or short) that aligns with the break out.

However, this is easier said than done!

Here we will talk about what goes in underneath the surface, and then how this can help us identify trading opportunities.

First of all, we have to put ourselves in the position of the party that is manufacturing this break out. Yes, most market movements are controlled,

they are NOT random. Of course, the underlying market has a fair price, and it is very difficult to manipulate price far away from this fair price. However, it is not difficult to manipulate the price so it moves a small distance

away from this fair price. And this manipulation occurs all the time, and this has been the case for more than a century in all financial markets. And it happens today, in ALL markets.
OK, so we have to understand there is one party who has taken the view that they want the

price to rise a little bit. It can be a small price rise, say from 1.31 to 1.32. This is a 100 basis point rise, and this is actually a major trading opportunity for short term traders. In the medium term, this is not very meaningful at all.

Here is what a typical break out looks like:

Obviously, the break out occurs from a trading range that has been established. This is key. Why? Because the Composite Operator (this is a term used by Wyckoff to illustrate that the multiple parties

who can control a market can be categorised as a single entity acting with an overriding aim, and this is the Composite Operator, or the CO)
The CO wants the break out to be sustained, and not fail. The best way to sustain a breakout, once it has started, is to get other traders

to start buying. If they do not, the breakout loses momentum and will likely fail.
How to motivate others to buy the breakout? They must feel that a breakout is occurring, in the first place. Then, they do not want to miss out on this movement, and they act quickly to buy.

This then, supports the breakout.

The two key human emotions that govern a trader are fear and greed. In, this case, if the trader fears he will miss out on the breakout, he will buy. If he already has a long position, his greed can tempt him to buy some more.

All in the hope that he is right!
So, how to create these two emotions in the market? The CO has to give them good reason to feel fear and/or greed!
The best way is to make it absolutely clear that a breakout is occurring, or MIGHT occur.

Look at this picture, and look to the left of the breakout, what do we see?

We see price behaving quite normally in a certain range. This sideways ranging is actually a good place for the CO to start to accumulate his positions. Remember, if the CO wants to engineer the breakout

we have to think : why?
The only logical reason is to move the price higher so he can SELL at this higher price. But sell what?
Well, he has to buy before he sells. So he uses this sideways range to quietly accumulate his long positions.

There are signs to tell us this is happening, but that is a different topic!
OK, so the range provides the opportunity for the CO to accumulate longs. It also, conveniently gives every trader a very visual cue – if price moves OUT of this range, then this MIGHT be a breakout.

If there is no established range, then how would we identify a breakout in the first place? A breakout from what, exactly?
Ok, So now we know the CO has built up a long position, and now he wants the price to rise, so he can then sell, and make a profit.

In theory, if he has deep pockets, the CO can just buy and buy and buy and the price will probably rise. But this is inefficient – the CO wants to buy at the LOWEST price he can, so why would he still want to buy while the price is going up?

He wants to build his long positions WELL BEFORE any breakout.
So, if he is not buying on the breakout, it must be the other traders (also called weak money, because they do what the CO wants them to do). So the CO must incentivise the weak buyers to buy to keep the breakout

going upwards.
So, first of all, the CO, once the price reaches the top of the existing trading range, he buys, and buys quite heavily.
Why does it have to be quite heavy buying? Because there are traders who will sell at the top of this trading range. Why?

Well, a lot of traders will already have positions in the market, if they are short, they will not want the price to exit this range upwards. So when the price reaches the top of this range, they will sell.

In addition, once the range is established, even if a trader has no position, he may simply expect price to reverse back when it hits the top of the range. So he, too, will sell.
That is why the CO needs to provide an impetus to the price to jump over this resistance level.

That is why you often see an increased volume in the candle that actually leaves this range:

Look at the first candle that breaks out above the blue resistance line, now look at the volume in the bottom section of the chart. It is the highest volume on the chart!

This means there is lot going on here – the CO is buying, and other traders are selling. It is a fight, and who will win?
Well, at the moment of the breakout, we have no idea who will win. We have to observe. If we jump in here and buy,

we are in fact the weak money that I mentioned earlier, and we are reacting exactly as the CO wants us to!

One of two things can happen. The sellers overwhelm the CO and the price is rejected, and falls back down sharply.

After this rejection, several things can happen. The CO can try again, or he may have given up on this breakout. In fact, we may find that the party that tried to affect this breakout is not the CO, maybe it is a smaller player

and in fact it is the CO who did the selling to reject this false breakout.
Nothing is certain, that is why we have to wait for the data and the charts to reveal the truth.
If it was the CO who tried to engineer this break out, he may simply take note that there is strong

selling pressure at this level, and then regroup and try again, and again and again.

Until the short sellers are all tired out, or run out of money. And then, the CO, having the deepest pockets, simply tries again, and there no short selling to resist him

In this case we would see a breakout on LOW volume, but this is still a good breakout.
Compare this to a breakout on low volume, that runs out of steam and the price falls back into the range. Both can look similar (breakout on low volume) but one will continue the break out and

one will cause the breakout to fail. The difference? The actions of the CO is the only difference.

Now, the CO will not hold up his hand and declare his intentions, but his actions do leave signs. We have to learn to read the signs, and this is not an easy skill to develop!

Now, if this IS a genuine break out, we often see increased volume because the sellers are trying to stop the breakout, and now new buyers are attracted because they see the chance that price might rise, and they are greedy, and do not want to miss out

– this weak buying is exactly what the CO wants. These weak buyers are providing the fuel for HIS breakout. This saves the CO himself from having to buy at this stage. Remember, he has already bought his long positions at lower prices,

so if he has to buy now at higher prices, this is highly inefficient for him. He just gets weak buyers to do the job for him.

In addition, the short sellers now might lose hope, they have no capital left to keep on selling, so they want to cut their losses

losses (remember they are short already, so any price increase is a further loss for them) so they CLOSE their short positions, meaning they have to BUY. This creates more buying pressure.

Now, the CO just sits back and lets the market do its thing

– he has seen the shorts run out of steam, he can see new weak buyers buying, and the price is rising.

But sometimes, the CO wants to make extra extra sure that the short sellers are exhausted. He will often engineer a retest of this level where the breakout occurred.

Or, if he is feeling extra mean, he might want to teach these new weak buyers a lesson and send the price back sharply into the range, so these weak buyers sell (and the CO will happily buy from them) thus increasing the CO’s long positions

But the CO does not want the take the price so low that new sellers are now interested, because if new sellers enter the market, the CO has to buy from them, and he has limited capital. And he can not control how many new sellers might enter the market,

so any push downwards by the CO (in a long breakout) can be risky. This is why he often makes extra sure he has wiped out meaningful selling pressure before the breakout.

After this, the CO may decide then it is the right time to continue the breakout.

I will talk about that next time, there is quite enough here for now : )

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