Breakout-and-retest setups

What you will learn

• How to confirm a daily breakout with a closing filter and a volume ratio
• What a retest is and why a former resistance level can act as support
• How to compare a breakout entry and a retest entry in risk, reward and R
• When a retest has failed and the setup is invalid

Explanation

A breakout is a move of price beyond a level that held it back before, typically the top of a range or a base (a sideways area that lasted several weeks). Ranges and basic breakouts are covered in the Trading course; this lesson adds precise confirmation rules and the retest entry, which is especially suited to swing traders who decide once a day.

Confirming the breakout

Many breakouts fail: price moves above the level for a few hours and falls back. Swing traders reduce, but cannot remove, this problem with two daily rules:

• Closing filter: count the breakout only if the daily close is above the level by a minimum distance, for example at least 0.5 ATR or a fixed percentage such as 1%. An intraday high above the level is not enough.
• Volume ratio: Volume ratio = breakout-day volume ÷ 50-day average volume. A ratio of about 1.5 or more shows above-normal participation. A breakout on below-average volume is weaker evidence.

A third, softer check is the base itself: a base of several weeks with contracting ranges (volatility contraction, covered in the Technical Analysis course) tends to produce cleaner breakouts than a short, noisy range.

The retest

After a breakout, price often moves back towards the broken level within a few days. This is the retest. The idea, often called polarity, is that traders who sold at resistance and missed the move, or who bought the breakout, may now defend the level as support. A retest entry buys near the level once it holds.

Define the retest zone in advance: for example from the level up to 0.5 ATR above it. Rules for a valid retest:

1. Price returns into the retest zone within about 2 to 10 trading days of the breakout.
2. No daily close more than 0.5 ATR below the level.
3. Selling volume during the retest is lower than on the breakout day.
4. Entry on a trigger, for example a break of the previous day's high or a limit order in the zone with a defined stop.

A retest fails when price closes clearly back inside the old range. This is a failed breakout, and the trapped buyers often add selling pressure. Exit; do not wait for a second chance.

Breakout entry versus retest entry

A better R on paper does not automatically mean a better strategy, because the retest entry only catches the breakouts that come back. You can only judge the trade-off by recording both in your journal.

Worked example

Hypothetical example: a base between €36.00 and €40.00 lasted seven weeks. ATR €1.20; 50-day average volume 300,000 shares. Breakout day: close €41.00 on 540,000 shares. Risk budget €120.

1. Closing filter: (€41.00 − €40.00) ÷ €1.20 = 0.83 ATR above the level. Passes (minimum 0.5 ATR).
2. Volume ratio: 540,000 ÷ 300,000 = 1.8. Passes.
3. Measured-move target: base height €40.00 − €36.00 = €4.00, added to the level: €44.00.
4. Breakout entry at €41.00, stop below the last higher low inside the base at €38.40. Risk €2.60 per share; reward €3.00 = 1.15R. Shares: €120 ÷ €2.60 = 46 (€1,886).
5. Retest entry at €40.30, stop €40.00 − 0.5 × €1.20 = €39.40. Risk €0.90; reward €3.70 = 4.1R. Shares: €120 ÷ €0.90 = 133 (€5,359.90).

Same euro risk, very different R and position size. The retest position is almost three times larger, so a gap through €39.40 would cost more in euros (see lesson 7). Excluded: costs, slippage and taxes. Measured-move targets are a convention, not a forecast.

Common mistake

Practice activity

Hypothetical data: resistance €25.00, base low €22.60, ATR €0.80. Breakout close €25.60 on volume 2.1 times average. Risk budget €90. Breakout entry €25.60 with stop €22.40; retest entry €25.15 with stop 0.5 ATR below the level.

1. Does the breakout pass the 0.5 ATR closing filter?
2. Calculate the measured-move target.
3. For both entries, calculate risk per share, reward in R and number of shares.

Key takeaways

• Confirm daily breakouts with a closing filter and a volume ratio.
• A retest enters near the broken level with a smaller stop and better R.
• The cost of waiting for a retest is missed trades; record both entry types.
• A close back inside the range invalidates the setup: exit by the written rule.

Next step

In the next lesson you study counter-trend swing trades and learn the situations in which you should not take them.