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Thursday, 20 December 2007 |
A false break can be one of the most depressing setups as a Technical Analyst. It doesn't have to be a bad thing though. There are ways to take advantage of false break set ups. The key is to understanding why a price declines further after a false break.
The Key
If you look below you will see an example of a false break. The price broke the resistance right before September began. Next, the price unexpectedly declines after the break and touches the resistance - This was the false break. The stock tries to break resistance again in the beginning of October, but fails and hits support.
What happens here is a line of support has formed, and traders set their stop losses right below that line. Once the price around October 12th reached the stop loss on the support, the stop loss orders were triggered, which caused a further declination in price.
What you should know
Traders set the stop loss on the support! Whether a fundamentalist or a technical trader, psychologically when look at charts, you see a point of support that you don't want the price to reach.
Here is another example:
This set up bares a false break with an ascending triangle - the channel is converging. The price broke resistance September 19th (notice the jump in volume), declines, and hit support finally on October 6th. Stop loss orders were triggered, which caused a large losses on the 7th. Ultimately, the stock has yet to recover.
Conclusion
Understanding the psychology behind traders decisions will yield insight into market fluctuations and movements. Knowing these reasonings will aid you to stay on top of your game and make a profit, when the majority lose any earnings.
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