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 a price breaks below its support line or above its resistance line, 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 at support and resistance in stocks and 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.
In this 15-minute chart on Finviz, AMD (Advanced Micro Devices Inc.) has a resistance level of $11.25. The stock gapped up above the resistance area 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:
According to Finviz, AMD 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 area 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. Knowing about support and resistance in stocks enables you to take the appropriate actions to increase your gains and avoid losses. 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.