There are many false breakouts. In fact, many traders will fade breakouts
to the up or downside as there are so many false ones and the profit
opportunity is worth the risk as long as a trader uses stops and manages
risk well.
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’s look at an example of a breakout
that may be failing in Biogen
BGEN rallied as many stocks have done in the past week.
A high reached on October 23, 2000 was the first high of the rally and an
area that I would consider buying a breakout similar to the breakout of 53
on October 19, 2000.
But, today BGEN hit a new high, and there was no follow through. A trader
must recognize these false breakouts and get out quickly.
I would exit longs in BGEN.
An aggressive trader may consider a short here with a 1 1/2 point stop.
