Indicator  |  FEB 2005

Directional Breakout Indicator by Barbara Star, PhD

Stocks & Commodities V. 23:2 (44-51): Directional Breakout Indicator by Barbara Star, PhD Price breakouts of moving averages present many profitable trading opportunities. Here’s an indicator you can use to detect breakouts and identify price direction. Despite the availability of more complex tools, moving averages remain one of the most popular methods that traders use to help identify price direction. Because they smooth data and reduce day-to-day price fluctuations, moving averages offer a rapid way to recognize bullish or bearish trends. Moving averages may also serve as points of support or resistance. As a result, price breakouts of a moving average alert traders to potential shifts in trend. The most familiar breakout occurs when the closing stock price crosses its moving average either to the upside or the downside, warning that a trend may be changing. That type of breakout often is accomplished with a single price bar. Sometimes, however, a tug-of-war between bulls and bears causes the moving average to cut through two or more consecutive price bars. This results in brief sideways price action, a neutral zone, which sets up another type of breakout as price eventually emerges from the neutral zone either to the upside or downside. Regardless of the type, price breakouts of moving averages present many profitable trading opportunities. Here is an indicator that detects both types of potential breakouts and identifies the direction that price might take following the breakout. THE DIRECTIONAL BREAKOUT INDICATOR According to conventional wisdom, the direction of the closing price in relation to its moving average at the time of the breakout forecasts subsequent price direction. When the closing price rises above the moving average, it portends a move to the upside. When the closing price falls from above to below the moving average, it warns that the price may continue to move to the downside. Even though reality often runs counter to conventional wisdom, there does seem to be enough truth in the predictive value of moving average breakouts to merit marking their occurrence.

by Barbara Star, Ph.D.