March 16, 2008
Free Stock Quotes
Stocks that are breaking out are usually very good profit-makers. That’s why you’ll often see us report that “XYZ could break out.”
A breakout occurs when a stock penetrates a previously formed resistance level and shoots ahead with no overhead resistance in the way. These moves can go for many points in a few days.
But you must understand resistance levels.
Suppose that you are watching XYZ every day and notice that it is moving ahead a little by the end of every session. By the end of the week it is up four points and you decide to buy if it is up at the beginning of the next day’s session.
Sure enough, XYZ is up the next morning and you buy at 50. Murphy’s Law then takes effect, and the stock falls five points the next day. Naturally, you aren’t happy and, more important, so are the 10,000 other people who bought the stock on the same day you did. Most of you are thinking the same thing: “If this thing gets anywhere near the price I paid for it, I’m out!”
So after a few days of consolidation XYZ starts to head back up. What do you suppose most of the owners of XYZ who bought it at 50 are going to do the second it gets to 49-1/2? Sell! And XYZ falls like a rock back to 45. The 50 price has become resistance.
Two things have happened. Another wave of people bought XYZ at 49.50, and they can’t wait for it to get up there again so they can get their money back. Also, traders noticed what took place. This is a dream come true for them because they highlight stocks that have formed a buy-sell “range” and start to trade it. They buy XYZ at, say, 45.00 and let it run to 49 and then short it so they can make money on the way back down to 45. This pattern–running up, whacking head at 50, falling back, regrouping, running up, whacking head–can be repeated many times.
But what happens when the XYZ finally releases some great earnings news, or its sector heats up so much that the stock finally punches through that 50 resistance line? Well, for one thing, a “short squeeze” is created. That just means all the traders that shorted XYZ figuring it was going to fall back to 45 now have to actually buy those shares as soon as possible to cover their short.
All that rapid buying along with the “new” money that is coming into XYZ because of the news release creates a fantastic supply-demand situation. All buyers and no sellers means that the stock price must go up to get people to sell it to the people that want it. When it finally does break out, it can go for a bunch real quick.
If you find a chart of a company that has rolled up to a resistance level and then fallen back three or more times, watch it closely every time it gets near that high again. If it finally breaks through its resistance and holds, chances are good that it will really fly from there. The key word is “holds.” You have to be patient and make sure it doesn’t pull back again. In general, if it holds above that resistance level for a full day, it is moving higher.
About the Author
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