Support, 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 look at an example of a potential breakdown in Sun Microsystems
(NASDAQ: SUNW).
Unfortunately, many stocks are exhibiting very negative patterns on a
technical basis. We have seen these almost all week long. Stocks forming
breakdowns from previous support, negative Head and Shoulder Patterns,
failed rally attempts with lower high highs and lower lows.
Many stocks are hitting lows that were hit on April 14 and breaking down
further. I am neither a Bull nor a Bear. I use technical analysis on
stocks and the market. Traditional technical tools are still pointing to
lower prices.
SUNW is an example of a stock that look ready to break support and also has
the negative Head and Shoulder formation that we featured last week.
Support is at 76 �. If SUNW breaks 76 �, I feel it will suffer the same
fate that we have seen so many other stocks this past week.
We also see a Head and Shoulder pattern with May 8-9 time frame the left
shoulder, the rally into the May 16 high as the head, and the decline of the
18-19 now forming the right shoulder.
If SUNW breaks 76 �, I would exit longs and consider a Short position in
SUNW.
If a Short were to be executed at 76 �, I would place my stop at 78 �
