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
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 Exodus Communications (NASDAQ: EXDS).
The reason that I choose EXDS is that its pattern is similar as to what I
am looking for on the NASDAQ market.
If we look at EXDS, the stock had a large gap opening on Friday, June 2,
2000, just like the NASDAQ.
A retracement after a large move like both EXDS and the NASDAQ had last week
EXDS today came down to almost fill the gap from Thursdays close. Then
EXDS moved higher and looks ready to take out Fridays high.
If EXDS breaks 90 3/8, I would Buy this breakout.
I would place a stop at 88.
If EXDS does not break to 90 3/8, do NOT take the trade.