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 Yahoo Inc.
(NASDAQ: YHOO).
One important lesson I have learned is that the stronger stocks tend to stay
stronger and the weaker stocks tend to get weaker.
If this looks familiar, this same pattern was being exhibited on April 10,
2000 at 150.
Here we are again looking at a weak stock ready to break support again on
May 30, 2000.
They say do not kick a man or a stock when it is down, but that is exactly
what you want to do with a stock. Looking at the drops in stocks and those
making new lows last week, most of those were making new lows the week
before too.
YHOO on Friday closed at its May 10 low, which was just above the April 17
lows.
It looks to me that YHOO will break this low and a new group of investors
will be bailing out.
Stocks that break support and resistance usually continue with that new
trend.
I would exit any longs in YHOO on any down move Tuesday morning,
An aggressive trader may want to consider a short here.
I would place my stop at 117.
If YHOO open up on Tuesday, do NOT exit or short the stock.
