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How To Predict and Spot Them.
How To Profit from Them.
Traders will inevitably find themselves owning a stock that
makes a false breakout like the ones show below. The hardest part
will not be in spotting the falseness of the breakout, but in getting
yourself to take a small loss. This is essential money management.
Take the loss. You can always buy the stock back if it makes
a subsequent high. The danger of a 33% loss or more is quite high.
Savvy traders look for these patterns to short. They know the
breakout has already forced the more nervous short sellers to
cover. Without short sellers to cushion the decline, prices
can fall a long way.
False Breakouts above Flat Tops Are Obvious and Often Very Bearish.
PAAS had already doubled in 7 months. That made the March breakout late. 20 is often
a significant psychological price barrier. The negative (red) Tiger Accumulation Index showed that
insiders were heavy sellers before, during and after the brief breakout in March. The plunge
on heavy volume below the 50-day ma proved the stock was in trouble. It subsequently lost
50% of its entire advance from 8 in July. This chart shows that OBV did confirm the breakout.
It was the Tiger Accumulation Index which gave you the best clue that the breakout was false.
BASIC TECHNICAL ANALYSIS
Good technical analysis requires a mastery of the concepts of support and resistance.
Inspecting charts, you will often see very traceable lines of support that go through a
series of lows made by the stock, index or commodity. Oppositely, a resistance line goes
through a series of highs. Some people use closing highs and lows to develop these
important lines. I have found intra-day highs and lows often make better lines, but it's the
closings that must move past the line for a breakout or breakdown. The support level may
have to be tested many times before a rally ensues. But once the support is seen as reliable,
prices typically get bid up to the overhead resistance line, if present. Similarly we see prices
sag once it becomes clear that a stock, index or commodity cannot get past a resistance
point. In this case, prices usually fall back to the most reliable line, or, sometimes, zone of
support. The DJI chart of 1986 shows the importance of recognizing support and resistance.
At some point the support or resistance level is overcome. The company's earnings picture
changes, new players come onto the scene, the Fed takes a different tact: all these and many
other pieces of news or developing stories can cause price breakouts or breakdowns. Prices
breakouts or price breakdowns usually bring a speedy move away from the previous trading
range or price hesitation pattern. After the breakout, prices are expected to move up or down,
at a minimum, the height of the previous trading range. Many times they move up much
further. And the breakout run are often very fast. This is why breakout playing is so popular.
Investors Daily has devoted whole segments of its newspaper to this concept. Breakout buying
has a long history of successes, but no where more so than in long bull markets. Read what
Jesse Livermore and Nicholas Darvas wrote about this exciting way of trading.
"Jesse Livermore noticed several things about stock market leaders in an up trending market. Their price
kept going up. Thats how you make money. He would look for industry groups that were leading the market
and trade only the leaders of that group. This made perfect sense. A leading industry group means only one
thing: there are more stocks going up than other groups. Not rocket science, but when you're risking your
own money, you don't want it to be. By trading only stocks in a leading industry group you can focus on that
small subset of stocks actually rising. He avoided weak stocks and their industry groups. The probabilities
were too great of losing money...
"If Jesse found a stock he liked, he would decide in advance how many shares hed buy. If he decided
to buy 400 shares of AAPL, hed first purchase 100. If the price increased, hed buy another 100; then finish with
a purchase of 200 shares if it kept rising. He needed confirmation that a stock would make him money. What
better way to confirm a stock price is going up than if its going up."
(Source: http://www.learnstockmarketlegends.com/jesse-livermore.html )
Read the reviews of the books by Darvas on Amazon.
All New Highs Are Not Breakouts
New highs do not necessarily entail a Breakout past well-tested resistance. There are
many more new highs that there are breakouts past a horizontal line drawn through at least
3 previous highs. It is breakouts that we are most interested in. But Tiger's internal strength
indicators validate new highs generally. MTH below made a new high, but had no flat well-
tested resistance that it moved above. So, it was not a "breakout" on 12/6 as we use that term.
Nevertheless, the falseness of its rally can be seen in:
1) OBV did not make a corresponding new high.
2) The Tiger Accumulation Index was less than half of what it was 2 months' earlier.
3). The ITRS (Relative Strength) did not confirm the new high and was an insipid .-3
Internet Search: "False Breakouts".
Diagnal breakouts like the one below are more suspect than breakouts above flat tops.
This writer says that such breakouts need to be confirmed by the Gold Stocks Index (XAU)
putperforming Gold (GLD), :RSI and MACD positive.
( http://www.financialsense.com/fsu/editorials/gnazzo/2007/0713.html )