The stair-step idea
In his three-setups article, Kullamägi writes that studying the biggest winning stocks of the past century shows them moving in stair steps: a move of 20 to 50% or more, a pullback and a sideways period, then another move. He describes this as how most leading stocks act, and as the behavior the breakout setup tries to exploit.
The three parts of the setup
The same article lists three steps:
A strong prior move
A big move higher sometime in the past one to three months, often 30 to 100% or more, usually over a few days to a few weeks.
An orderly consolidation
A pullback and sideways range with higher lows and a tightening range, usually lasting two weeks to two months.
A range expansion
The breakout itself: price leaves the consolidation with a wide-range move.
Finding the first part is what the 1-, 3- and 6-month leader scans are for. The second part is where most of the chart reading happens. The third part is the trigger, usually taken at the opening range high as covered in opening-range highs.
Surfing the rising averages
The article describes price during the consolidation as surfing the rising 10- and 20-day moving averages, and sometimes the 50-day. In practice that means the lows of the range keep meeting a moving average that is itself pointing up, instead of slicing through it. A base that loses its averages and flattens them is a different, weaker picture.
The same averages reappear on the exit side. Once a breakout works, the article describes selling part of the position after a few days and trailing the rest with the 10- or 20-day average; that framework is covered in trailing winners with the 10- and 20-day moving average.
Shapes and timeframes
The article says the setup has variations but the premise stays the same, and names some of the shapes: flat channels, symmetrical triangles and descending triangles, with some daily examples also called high tight flags. It also says the pattern works on weekly and intraday (1- and 5-minute) charts as well as the daily chart used for swing trading.
Measuring a consolidation (our template)
The fields below are this site's own study template for turning the description into numbers you can compare across many charts.
- Prior move: percent gain from the start of the move to its high, and how many sessions it took.
- Depth: the largest pullback from that high, in percent.
- Length: sessions from the high to the breakout day.
- Higher lows: how many distinct swing lows, and whether each sits above the last.
- Tightness: the daily range in the last five sessions compared with the stock's ADR.
- Average: which moving average the lows were holding at the breakout.
Log failures with the same fields. Comparing bases that broke out and ran with bases that broke out and failed is where the template earns its keep; see studying failed breakouts.
The base review checklist
- Is there a strong move in the past one to three months?
- Is the pullback orderly, with higher lows?
- Is the range tightening into the right side?
- Are the lows holding a rising 10- or 20-day average?
- Has the base lasted roughly two weeks to two months?
- Is the trigger level and the low-of-day stop defined in advance?