involves a situation where the price ‘breaks out’ of its previously defined range
. A breakout occurs when a stock price rises above its current resistance
level, or falls below the existing support level, and this movement is accompanied by a high volume of trading.
If a movement outside the levels of support or resistance occurs with a low volume of trading, this may not indicate a true breakout, but rather a fake out
– a breaking of the support or resistance levels that does not indicate an oncoming trend, but rather a dramatic short-term price move that will subsequently revert to within the trading range
As soon as price crosses the Breakout line there is a tremor of excitement. Conditional buy orders placed in anticipation of a breakout are triggered. Traders watching their screens notice the activity and send in a flood of new buy orders; everyone hopes to get on board before price rallies too far above the former resistance levels. And who is standing in the face of the rally, happy to accommodate them? Our market professional releases a steady stream of sell-orders into the market, careful not to saturate the market until he has offloaded most of his stock.
Other professionals pick up on what is happening and start shorting the stock. The rally fizzles and the punters are left high and dry. Price retreats back below (the Fake out) the new support level (formerly resistance) and triggers their stops. A fresh round of selling ensues as the punters struggle to clear their positions. The professionals cover
their short positions and go home having made a tidy profit for a few hours work. It's a hard game -- you have to live by your wits -- but the rewards are big.