7-04 Breakouts
A breakout occurs when market prices move through and continue through former highs or lows that had formed ceilings or floors in the past. Commonly called levels of “support ” and “resistance,” these former limits are breached during a breakout. They are key zones or areas where the price has difficulty passing through.
A support level is a zone or area where the selling pressure becomes weak and the buying pressure grows stronger. The stock price has difficulty passing below this level and will bounce back up again. Eventually the support will fail and the price will breakthrough. There are two key features to a support level:
- The support is an area where a lot of traders have placed their limit orders to buy the stock at that level.
- If there are more buyers than sellers at this level the price will bounce and go up.
A resistance level is a zone or area where the buying pressure becomes weak and the selling pressure grows stronger. The stock price has difficulty passing above it and will bounce back down, eventually it will fail and the price will breakthrough. These are the key features of a resistance level:
- The resistance is an area where a lot of traders have placed their sell orders on the stock at that level.
- If there are more sellers than buyers at this level the price will bounce and go down.
The best example that will truly explain this is with the Amazon (AMZN) stock. It has been trading within the price range of approximately $3000 to $3500 from July 2020 to July 2021.
This chart is rather easy to understand as you see historic peaks and valleys that are fairly consistent, when suddenly the most recent trendline quickly moves up or down toward new highs/lows. The duration of the trading range for which the breakout occurred can provide an indication of the strength of the breakout to follow. The longer the duration of the trading range, the more significant the breakout will be.
A classic breakout occurred for Gold (GLD) in autumn 2009. After twice getting halted at about $1,000/oz ($100 for the ETF GLD), it blasted through this resistance level as can be seen in this 3-year chart.
