Support and Resistance and Breakouts
Think of security prices as a war. It is a battle between a bull (the
buyer) and a bear (the seller). The bulls push prices higher and the bears
push prices lower. A buyer that feels an area has good value, will buy at
that level. The seller that feels that a stock has reached fair value, will
sell at that higher fair value price. The direction prices actually move
reveals who has won the battle.
Remember when a trade takes place, a buyer and seller agreed to a price.
There was a buyer and a seller involved in the transaction. The buyer feels
the stock will go up. The seller wants to move on to another stock that he
may feel will appreciate faster.
Support levels are the price where the majority of traders feel the value is
a good buy.
Resistance is the level in which the majority of traders feel prices will
move lower.
When the majority of traders and investors change their expectations, these
support and resistance areas get violated and a new trend may be beginning.
This can occur due to changes in expectation of earnings, new product
development, change of personnel, cut backs or expansions.
One interesting pattern that traders see after a breakout is that the stock
or index retraces a part of the initial move by about 50%. If the 50%
retracement does not hold, the stock or index can still be in a trend if the
previous breakout resistance holds.
Let's look at Legato Systems (NASDAQ: LGTO).
Breakouts can show in a variety of patterns. Many times we are looking at
stocks breaking to new 52 week highs. However, there are many excellent
opportunities to trade a stock breaking 20 day highs, monthly highs, or 3
month highs.
We have seen some stock disasters do to missing earnings, changes in
management, lawsuits, accounting irregularities and other factors.
Many traders want to just buy these disasters, but I like waiting for a
channel of support and resistance and playing the second or third breakouts.
LGTO had a disaster back in mid January dropping from 55 to 28.
After a couple of weeks of continued pressure, the stock is had a series of
small channel breakouts to the upside.
Once again today, March 27, 2000, LGTO broke a 10-day trading high. In
fact, LGTO broke a 3-month high today.
I would look for LGTO to continue up to possible fill the gap to the January
price range in the mid 50’s over the next few days.
I would Buy LGTO on any up opening or intra day rise above today’s high of
46.
I would place a stop at 43 �.
