Breakouts from patterns are not always clean and can cause tactical problems with entry and sizing. In fact, it is often the case that a trader can lose money trading a difficult breakout even if the market proves the trader right.

Copper is a great case study.

On Oct. 20 and 21 it was apparent that Copper was forming a possible H&S bottom with an extended right shoulder (meaning that the right shoulder low was futher from the head low than was the left shoulder low).

Marked “A,” the strong advance on Oct. 24 was a good indication that this pattern was a real possibility, even though the market did not penetrated the neckline. The Oct. 24 low was 322.30.

Marked “B,” on Oct. 25 the market penetrated the neckline, but closed weak. The H&S bottom was not completed on a closing basis. However, increasingly breakout days that close back within a pattern can be used as the basis for a protective stop. A purchase at unchanged or lower on Oct. 26 could have used the Oct. 25 low as a stop-out point.

A characteristic of a valid upside breakout is that a series of higher highs occur even if the breakout is sloppy.

Marked “C,” the market finally confirmed the H&S bottom with the close on Oct. 26. However, buying the close on this date at about 351 would carry a risk to below the same day’s low at 339.60.

Let me move this case now to address position sizing. I am a believer that risk should be limited to no more than 100 basis points, or 1% of the total size of a trading account (or composite of accounts). This means that a long taken on the confirming close on Oct. 26 had a risk of approximately $3,000 per contract.

Under my risk rules, and using a stop that makes technical sense and is not just an arbitrary dollar amount, $300,000 would be the minimum sized account that could have bought Copper on Oct. 26.

Copper has an upside target of around 396.

$HG_F

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