Even textbook chart patterns fail sometimes. It happens with nearly all indicators and tools used in technical analysis, since it’s more of an art form than a science.
You can’t control what happens, but you can avoid being trapped by fakeouts.
When price breaks below support or above resistance, you want to see confirmation before getting into or out of a position because it could be a fakeout. That said, let’s take a look into how you can avoid false breakouts.
Support and resistance explained
Resistance and support lines are widely used by chartists to provide an indication of where buyers and sellers, respectively, are willing to step in. Support lines act almost like a “floor” price. In other words, the stock tends to bounce off of support lines due to buying pressure. However, if the price breaks below the support area, it’ll look to another area of support.
The opposite is true with resistance, where the lines act like a ceiling and a stock may run up to the next level of resistance..
Let’s take a look at a fakeout breakout now.Source: TradingView
In the 15-minute chart on Advanced Micro Devices Inc. (AMD) above, the $11.25 area is a resistance level. The stock gapped up above resistance level and nearly hit $11.50. If you got into the stock looking for it to build momentum after it broke through this resistance level, you would have been trapped by the false breakout.
Here’s a look at what happened:Source: TradingView
The stock ultimately pulled back below $11, leaving you “trapped” by the false breakout.
Rather than getting right into a position off of a breakout, look to see multiple periods of bullish trading, above the resistance line for confirmation of a breakout.
The same could happen for support areas, but we’ll leave that up to you to do for homework.
Traps are pretty much everywhere when you are trading off of technicals, and it takes effort to avoid these landmines. If a stock breaks above the resistance area, wait to act until there is additional bullish price action. Similarly, if a stock breaks below a key support level, wait for a continuation in bearish price action to confirm that you’re witnessing a real breakdown.
Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.