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Trading breakouts with stage analysis
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Trading breakouts with stage analysis

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Trading breakouts with stage analysis

My aim with this journal is to forward test Stan Weinstein’s four-stage breakout method that he describes in his book from 1988. As with hindsight, you can see that the method works beautifully to this day. However, it’s not as easy to make decisions at the right edge of the chart that look obvious with hindsight. So I plan to follow his method as closely as possible, but I’m also going to use point and figure charting methods for additional confirmation and to aid with the stage identification and breakout points.

I like to read a lot and have tried various methods over the last four years since I began to learn to trade and I imagine I’ve got many more years to go yet before I become consistently profitable. However, my goal in the short term is to try and develop my discipline and to stay focused while I test this method and not deviate from my plan. As I need to be consistent in my approach to see whether the system works or not, as otherwise I might disregard the method if I fail, when it was actually not the fault of the system, but my own short comings that caused the failure.

I’m currently on my third reading of Weinstein’s book as I’m keen to fine-tune my understanding of the four stages so that I can try to identify the A+ situations that he talks about, which are most likely to turn into the biggest winners over time and try to avoid the C- mediocre buys and false breakouts.

I won’t go into the whole method in this first post, but it is based on buying breakouts when the general market trend is positive; that are in the strongest sectors; that are breaking out into stage 2 with minimum overhead resistance; which have strong increasing volume on the breakout and also have good relative strength versus the market overall.

The method is based on buying stocks, but is also supposed to work just as well on commodities and indexes. However, from studying the charts I don’t think it is as suited to forex, although the stage analysis still seems to work very well, so I think it could still be a useful method in the toolbox for fx. But I’m going to limit my trades to stocks, indexes and commodities only to begin with and see how I get on.

I hope you enjoy the journal and I will appreciate any constructive feedback, especially from people that have tried the method or trade in this way.

Cheers

isatrader


Last edited by isatrader; October 30th, 2011 at 03:20 PM.
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Quick Summary
Quick Summary Post

Here are some quick links to my posts about the method

Post #11: Definitions of the Four Stages - The stages are explained in detail, followed by 12 posts with charts of the individual sub stages.

Post #7: Buying Reference - When to buy reference guide

Post #38: Triple Confirmation Pattern - Uncovering Exceptional Long Term Winners

Post #9: Market Breadth Charts - My secondary indicators used for additional confirmation and help with identifying the current market stage.


Last edited by isatrader; October 30th, 2011 at 03:41 PM.
 
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US Dollar Index Stage Analysis


Charts moving into stage 2 are thin on the ground at the moment, but attached is the US Dollar index chart. It has recently broken out of a stage 1 consolidation that started forming back in April this year. The 30 week moving average has turned higher for the first time in over a year. Volume has increased on the breakout from the range and relative strength versus the S&P 500 has increased and moved into positive territory. So by my interpretation of the method this is the beginning of a new stage 2 uptrend. However, although it meets the majority of the criteria in Weinstein's method, one crucial area is not so positive - overhead resistance. There is significant resistance above the breakout which will likely limit any advance that it tries to make. The 82 level looks like strong resistance in the short term IMO, which could be bullish for stocks and commodities if it tops there and begins a new range.

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Trading breakouts with stage analysis-us-dollar_stages_26_9_11.png  

Last edited by isatrader; September 28th, 2011 at 07:47 AM.
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US 30 Year Treasuries Stage Analysis

The US 30 year has had a fairly model stage 2 since it's breakout in early May. It moved up to previous resistance on increasing volume, then pulled back towards the breakout level and the volume contracted giving a second lower risk entry point early in July. Currently it's still in a strong stage 2 rally. However, it's a bit extended from it's 30 week MA, so the trader stop loss position would move inside the MA to below the most recent low which is around the 137.50 level. But the investor stop would be just below 130 I think.

I've included the daily chart as well on the attached chart below.

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Trading breakouts with stage analysis-us-30-year-tresuries_26_9_11.png  

Last edited by isatrader; September 28th, 2011 at 07:47 AM.
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S&P 500 Stage Analysis

The S&P 500 is in stage 4 downtrend currently. One of the key criteria of the method is that the market trend must be positive if you are buying stocks and negative if you are shorting. So as the S&P 500 is currently in a stage 4 downtrend, I would only be allowed to short at the moment.

I've attached the chart below with the four stages marked up over the last year. The current consolidation seems to suggest it could be early in a new stage 1, but this could easily give way and break to the downside again as the 30 week moving average is still a way off and would need to start to flatten out a bit to have more confidence.

I think one of the things I like the best about this method is that stops you from jumping into buying a stock too early, which I've been guilty of many times over the years. So hopefully it will help me to be more disciplined with my timing.

Attached Thumbnails
Trading breakouts with stage analysis-sp500_27_9_11.png   Trading breakouts with stage analysis-sharpchartv05-24.png  

Last edited by isatrader; September 27th, 2011 at 05:35 PM.
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Point & Figure Volume

I've been experimenting with adding volume to point and figure charts this morning, as volume is so integral to the method for confirmation and I thought it would be interesting to see if the volume data looked clearer on a P&F chart, as P&F charts do such a good job of filtering the noise on the price action.

The initial results are promising. Have a look at the S&P 500 volume levels on the major breakouts over the last few years:

S&P 500 Mar 2009

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S&P 500 August 2009

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S&P 500 September 2010

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I think that this will help me to filter out some of the false breakouts as the method calls for at least twice the average volume on the breakout, otherwise you should take a quick profit and get out of the position as it's likely to reverse if it doesn't have the volume to back it up. So for example, looking at the volume at the moment in the current chart, it looks anemic and has been all year. So I'd want to see a big volume bar on any breakout above 1230 and a contraction in volume on the pullback following any breakout as you can see in the other breakouts above.

S&P 500 Current

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Last edited by isatrader; September 28th, 2011 at 06:16 AM.
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Buying Guide

As the market trend is in a stage 4 downtrend at the moment and I'm already short the S&P 500 from this weeks bounce to the near the top of the daily channel yesterday. I'm going to spend some time over the next few weeks/month studying the method more and trying to get some watch lists set up of stocks/commodities in stages 1 and 2 and that are outperforming the market since the August low, so that if the market trend turns positive again over the next month, that I'm ready to buy the best looking candidates.

I've been reading the "refining the buying process" section again today and thought it would be useful for me to write down the buying reference on the first page of my journal so that I can reference it easily in future.

Buying Reference
  1. What is the major trend of the market overall
  2. What groups/sectors look the best technically
  3. Create a watch list of the stocks from the sectors identified that have bullish patterns but are currently in a trading range. Make a note of the breakout price level of each.
  4. Narrow the list by discarding the stocks/commodities that have overhead resistance nearby.
  5. Narrow the list further by discarding the ones with the worst relative performance versus the general market - I use the latest major low in the S&P 500 as my baseline for this.
  6. Put buy-stop orders on for half the position on the few stocks/commodities that meet the buying criteria.
  7. If volume looks promising on the breakout and then contracts on the pullback towards the initial breakout level, then buy the remaining half of the position.
  8. If volume doesn't increase enough on the breakout then sell on the first rally. If it doesn't manage to rally and falls back below the breakout point then dump it immediately.
So that's the quick reference of the most important things to do when buying with the method, which I'm going to try to stick to from now on.


Last edited by isatrader; September 28th, 2011 at 07:09 PM.
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Looking forward to your journal. Nice to see some PnF charts.

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Market Breadth

I like to use market breadth charts in my analysis to try to help to gauge the risk in the broad market. I focus on four charts especially which are:

NYSE Bullish Percent Index ($BPNYA) - this is a compilation of the percent of stocks that trade on the NYSE that are on Point and Figure buy signals and tells you whether to be offensive or defensive with your strategy.
  • Xs = offense
  • Os = defense
  • 30% and 70% are the oversold and overbought areas where risk is highest
  • All stocks have an equal vote
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NYSE Percent of Stocks above their 200 day moving average ($NYA200R) - this is a measure of the percent of stocks on the NYSE that are trading above their 200 day moving average

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NYSE Percent of Stocks above their 50 day moving average ($NYA50R)- this is a measure of the percent of stocks on the NYSE that are trading above their 50 day moving average

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SPY/TLT - this is the ratio between the S&P 500 and the US Treasury bonds, which I use as a measure for the risk on/risk off trade. I find it a very good guide, as the signals last for a long time generally, although it can have the occasional false signal. But since the beginning of the 2009 rally there's only been 3 signals as you can see on the chart which would have kept you on the right side of the market.

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I tend to look at these charts at least once a week as a group, as individually you'll see that they can experience whipsaws from time to time and give a false signal. However, as a group I find them very robust and a great guide to whether I should be looking to buy or looking to sell.

I'll be referring to them frequently in my journal, and I'm keeping an especially close eye on them at the moment as the percentage charts are all in the lower range and a break above 30% on all three would make me keen to get back into stocks on the long side. However, these are only secondary charts as I'm trading Stan Weinstein's method, so I'd need all the buying criteria I mentioned before to be in place before I got long again. For now they are all on the sell side so I'm staying short for the time being.

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Gold Analysis


I like to trade the precious metals, so I thought I'd try and make sense of what gold is doing at the moment.

The weekly chart is in Stage 2B I believe, but the pullback to the 30 week moving average has been a little bit more extreme than the previous pullbacks over the last two years, so it's possible that it could be the beginning of a Stage 3 range. However, the moving average is still rising for now although it is slowing which is why I think this is Stage 2B and not Stage 3 yet.

On the daily chart I had a measured swing target of 1585 from the Stage 3 top, which has been reached. However, the daily chart is in a Stage 4 consolidation currently, so I'm not looking to buy until it forms a stage 1 base and manages to breaks out into a new Stage 2 following the rules of the system, as it could just as easily break lower. So I'm still on the side lines for now.

Below is my charts

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