TRADING TECHNIQUES
Catching DJIA Breakouts
by Mark Vakkur, M.D.
Buying breakouts in the Dow Jones Industrial Average works well -- but there are caveats.
If the trend is your friend, the simplest way to use that idea is to buy only those markets that are breaking out to new highs. But is this really a good strategy? As it turns out, at least for the Dow Jones Industrial Average (DJIA), breakouts are very useful in identifying periods of increased profitability. I studied breakouts on the DJIA from February 1988 to November 1998. If breakouts truly are useful, buying a breakout over this 11-year span should have led to a greater than average subsequent four-week and eight-week profitability.
FIGURE 1: VISUAL TESTING. Simply finding the highest high of a given lookback period identifies breakouts well on a weekly chart.
Obviously, the DJIA has been in an extraordinary secular bull market since 1982; it may behave differently in a downtrend or a trading range. Many market players are now used to buying high and selling higher. I leave it to you to apply the concepts presented here to your tradable of choice. That said, here's how the DJIA performed following breakouts.
SOME DEFINITIONS
Using EasyLanguage, I created a function that tests to see:
1 Is the high of this bar greater than the highest high of a given lookback period?
2 If yes, is this the first time a new high was set during the lookback period?
What I really want to do is to isolate only those highs that are true breakouts. I want the first new highs in a certain period.
One of the easiest ways to test the usefulness of the breakout is to write a simple system to do so. Therefore, I set as the entry point the close of the first bar at which the condition was met (see Traders' Tips). Then I sold at the close a certain number of bars later. This answers the question of how the market performs for x number of bars after a breakout.
RESULTS
When I applied the system to a weekly chart of the DJIA, I got a chart like the one that can be seen in Figure 1. I used a lookback value of 4 (meaning I sought breakouts of four weeks or greater) and I automatically sold in four weeks.
Mark Vakkur is a psychiatrist and a stock trader. He can be reached via E-mail at mvakkur@hotmail.com, or via http://www.members.xoom.com/mvakkur.
Excerpted from an article originally published in the August 2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2000, Technical Analysis, Inc.
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