Breakout (a.k.a. Resistance Line Breach) and Role Reversal
If a resistance line is penetrated by a significant amount, or the price stays above this line for a prolonged period of time, we can speak of a breakout. The resistance line becomes a support line, i.e. a line off which the price is more likely to bounce than to cross it from above – it is a concept contrary to the one of resistance. The same psychological factors (such as grief and regret) as in the formation of resistance play an important role in this case. An example of a breakout and a silver resistance line becoming a silver support line can be seen in the chart below.
Let’s focus on November-December 2007. Silver moved back and forth in the proximity of the 2007 top. In such an environment, the 2007 high served as resistance. The several failed attempts to move above it suggested that this line was potentially an important resistance, which could result in significant moves. At the very end of 2008 silver moved above this line, confirmed the move (you will find more on confirmations below). This breakout was a potentially bullish development. As it turned out, silver continued its upward move for months, moving from around $15 to around $21. In this specific situation, the analysis of breakouts would have paid off handsomely.
Verification of a Breakout
In order to consider a violation of a resistance line valid, at least one of the criteria listed below should be met:
- The move above the resistance line should be significant. There is no clear rule telling what constitutes a significant move. Some use 3% as a benchmark in the case of important resistance levels and 1 % for the short-term ones.
- It should be accompanied by high volume
- Price should close above the resistance level for 3 constructive trading days to confirm the breakout.
The idea of resistance is a fundamental one in technical analysis. It can be very useful in making investment decisions as it allows a trader and an investor to predict certain market moves.
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