The 'Second Chance Breakout' Day Trading Strategy

Second chance breakouts are excellent trading opportunities

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Figure 1. Second chance breakout entries on chart patterns. FreeStockCharts.com

Missed a big breakout, but still want to get into the trade? The second chance entry strategy provides a way, and in some ways is better than trading the original breakout.

What's a Second Chance Breakout?

When the price is within a range, triangle, head and shoulders, or other chart pattern, there is a breakout point (when the price moves outside the pattern). If the breakout is legitimate (doesn't fail right away) then the price continues to run in the breakout direction.

This shows the price has a clear direction, but quite often (but not always) after the price has broken out it will come back and "re-test" the old breakout point. It doesn't have to touch the old breakout point, just come relatively close to it. When the price does this, it provides a second chance entry. 

Figure 1 (enlarged version) shows two breakouts which both provided second chance entries. The first occurs at the neckline of a head and shoulders pattern, and another following a small channel. 

Trading a Second Chance Breakout

If the price breaks above a chart pattern, then the second chance entry provides a buying opportunity. If the price breaks below a chart pattern, the second chance entry provides a shorting opportunity.

When the price enters the vicinity of the old breakout point, be on high alert for a trade. Once the pullback has slowed down and the price is starting to move in the original breakout direction, take the trade.

 

"Starting to move in the original breakout direction" is subjective and a more rule-based approached is preferred. For example, an engulfing candlestick pattern could be used to signal the pullback has ended and is starting to move in the original breakout direction.

If the original breakout was to the downside, wait for a pullback toward the original breakout point, and when the price begins to drop again enter short.

Place a stop loss a couple cents/pips/ticks above the pullback high. Usually, this approach keeps the risk quite small (stop loss isn't far from entry point). The target for the trade is based on the chart pattern and the original breakout price. The height of the pattern is subtracted from the breakout price. How to calculate these profit targets is covered in more detail in How to Trade the Head and Shoulders Chart Pattern and Low Risk High Reward Triangle Day Trading Strategy.

If the original breakout was up, wait for a pullback lower and when the price begins to rally again enter long. Place a stop loss a couple cents/pips/ticks below the pullback low. The target for the trade is based on the chart pattern and the original breakout price. The height of the pattern is added to the breakout price.

Figure 2 (click to view) shows the same chart, expect this time stop losses and targets have been added. Both trades could be taken, or only one. An alternative to the chart pattern targets is to use a fixed reward-to-risk ratio. For example, 3:1 or 2:1. If risking 8 pips on a trade, a 2:1 ratio places a target 16 pips from the entry price, or 24 pips if using a 3:1 ratio. Which method is used depends on the broader trend and should be laid out in a well-defined trading plan.

Considerations

Breakouts can be difficult to capture, so the second chance breakout provides a way to trade a breakout after it has already proven itself. No more losing money on false breakout after false breakout. Unfortunately, a second chance entry doesn't always occur. Some breakouts are so strong that a viable pullback to trade doesn't materialize.

While the pullback for the potential second chance entry is occurring, wait for the price to start moving in the breakout direction again before entering. There is no guarantee the old breakout point will stop the pullback, so placing orders in advance, near the breakout point, isn't advised.

This strategy works best as an active strategy, where you're sitting and watching for the day trade to trigger, as opposed to a "set and forget" type strategy.