Ripe for Breakout Failures

[PristineTrading 10]

As markets and stocks move higher and then higher again with very little retracement or sideways corrections the potential for breakout failures increase. Because of the surprise or shock to traders playing the breakout, these failures can produce great opportunities for swing-trading over a few days and even higher odds day-trading opportunities. Let's look at a couple of examples that have happened and some current patterns that may.

 

As with all Pristine trading patterns, understanding the thought process of traders that created the pattern is an important component to having confidence in the play. The breakout failure pattern is an easy one to understand since everyone has been caught in one at some time in the past. But let's review it.

 

As prices are trending higher, traders are waiting for an entry point to get on board the trend. The most popular entry is when prices pullback to a reference point of support. Some traders will use a prior high, a moving average, a percentage of retracement or simply a dollar about. However, when prices move sideways (a very strong tread), rather than retrace, the trader is confronted with the choice of having to buy a breakout. If the breakout results in prices falling back under the breakout bar's low, the unexpected or shock has happened. What are you going to do?

 

Breakouts are high odds trading setups, however, they are best used after the initial start of a move. This could be after the first rally from a bottom phase or it could be a gap-trading setup where the gap was a daily Pro-Gap, followed by prices basing for a period of time intra-day. Breakout failures increase when prices have been trending higher for a long time or have moved too far, too fast.

 

There aren't a lot of these failures happening yet, but there are a couple that I can show you and a few that might result in failures.

 

 

Last week, Deere (DE) broke out above a several day base and at the time it looked like higher prices were a sure thing. However, the next morning DE gapped well below the breakout bar's low. Can you imagine the shock to traders and fund managers that had bought the breakout the prior day? DE is an example of prices moving too far, too fast. Think about what you would do if you bought DE and it continued to show more weakness. What if you were a fund manager with cash on hand and starting buying a lot more shares of DE, but sellers just kept on dumping, so price barely moved up. Are you feeling it?

 

 

In the above chart of Castel Crown Intl. (CCI), the daily time frame actually looked good for a breakout to continue. The base was a reasonable length and it was forming at the top of a Bullish Wide Range Bar (+WRB). However, the weekly was up from its base five-weeks in a row. Now, that doesn't always mean the breakout could not have worked, but it was lower odds. That being said, the breakout failed when prices broke under the breakout bar's low. It's shock-time for the breakout traders, what are you and other traders going to do?

 

 

HCN has been moving up on the weekly time frame since the end of last year, and notice that last week's range was the widest since the move started. In addition, it closed almost at the high of the week; no wick or upper shadow. In other words, buyers were falling over themselves to get these shares after multiple weeks of a straight up run into a weekend. Thinking must be that there is no risk of moving lower. Hum, well maybe that's true and we'll see. Friday, HCN broke out above two bars with equal highs. That was a minor stall of course and not what many would consider a base, but this is what strong trends do. If prices break under Friday's low it will come as a big surprise to those that bought last week.

 

 

Universal INS Hldgs. (UVE) has had a big run this year and may move higher still, but right now it looks ripe for a breakout failure. Last week's range narrowed after the prior week having had a huge range. That signals that the bullish momentum reached an extreme and then slowed. Buyers of UVE are not expecting a move under Friday's low, so if prices do - the trap will be set.

 

 

Lastly, here is a chart of the S&P 500 ETF symbol SPY. It also broke out above two prior days with relatively equal highs Friday. Buyers stepped up all day Friday and when there was no pullback mid-day, they scrambled to buy shares right into the close. Notice the size of last week's range compared to the prior ones.

 

If SPY breaks under Friday's low, it will be a shock to those recent buyers and that is likely to bring in sellers short-term. However, it will not change this bullish uptrend simply because the trend will still be up.

 

What I have shown you in this Chart of the Week (COTW) is how to recognize one type of failure/shock pattern. Educated short-term day-traders and swing-traders know how to take advantage of these moves when they happen.

 

If you are holding long in this market for the intermediate-term there is nothing for you to do. That being said, watch to see if there are any breakout failures next week and what happens.