Breaking Through Resistance

October 8, 2007 at 11:25 pm · Filed Under Educational 

If I was playing basketball and I had a layup from 5 feet away, it would normally be a good shot. What if Yao Ming and Dwight Howard were both right in front of me trying to block my shot though? It suddenly turns into a pretty low percentage shot. The attempt from the exact same spot on the floor can either be a sure 2 points, or a certain disaster waiting to happen, depending upon the situation.

Stocks often encounter the same issue. Sometimes a company is good, but the situation just isn’t right for you to buy their stock at that moment. In order for a stock to advance, not only does the company have to be first-rate, but other people have to realize it and bid it up too, otherwise the stock will just sit at the current price. By not going up, a stock is actually doing worse than just not making money for you; it also has opportunity costs since your money is tied up and not earning what it could be in other places.

While there are many different techniques to increase your odds, learning to trade breakouts is one way of making higher percentage plays and removing Yao Ming and Dwight Howard from the picture. Most stocks seem to hit some resistance that they struggle to get over when they start going up. Apple started releasing iPods at the end of 2001, and the savvy investor might have taken notice of their stock when the hype started rolling. It wasn’t until 2004 that the stock started really moving though.

Notice how the stock hit $12.50 multiple times, but didn’t get above it for a while. You could have wasted months or even years waiting for others to realize what you already knew, that AAPL was a good stock. However, if you would have had some patience, you would have waited until the breakout (circled above) and purchased AAPL when it had the high volume surge above the resistance at $12.50. High volume breakouts indicate lots of buying by large players, who typically don’t trade as much, and will lend support to the stock around the breakout level. Not only does this clear out the overhead supply (people who have a loss on the stock), but it gives another confirmation of the positive sentiment you had on the stock in the first place. Let’s face it, the iPod might not have been as big of a hit as you thought in the beginning, and AAPL might have been heading down to $2 rather than up to its current $160.

Making money in the market is all about making higher percentage plays. While you may be able to throw in a prayer here and there while Yao and Dwight are guarding you, it’s a better play to pass the ball out and look for another shot. Rather than forcing a trade on a stock that’s in an undesirable place, don’t be afraid to pass on it for the moment. Sometimes you’ll make some money on these bad plays, but in the long run your account will thank you for being more judicious.

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