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 breakout in Commerce One
(NASDAQ: CMRC).
Many stocks have already broken out from basing patterns. These are both
hourly and daily breakouts to new 3 day highs, weekly highs, and even
monthly highs.
CMRC is a stock that was really beaten down from a March high of 137.
CMRC hit a low of 29 on April 17, 2000. Like many stocks, CMRC is now
forming a base and looks ready to breakout in a possible new uptrend.
If CMRC breaks today’s high of 41 1/8, I would buy the breakout at 41 �.
I would place a stop at 38 �.
If CMRC does not break 41 1/8, do NOT take the trade.
