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VOLUME ON THE
BREAK OF IMPORTANT SUPPORT
VOLUME ON THE BREAK OF
IMPORTANT SUPPORT
In last week's "Inside The Black Box" section
we saw the importance of volume on the breakout above a key resistance
level. If a stock breaks above key resistance on just average daily
volume, then the breakout is likely to be suspect. That is, there is a
good chance the shares will travel a little way above the key resistance
level, then turn around and retreat into the former trading range. If
the swing trader is not alert, then he or she is liable to get trapped
into a losing trade (or at best, holding a stock that's going nowhere).
On the other hand, when volume expands dramatically on the breakout, it
shows that buyers are willing to "pay up" to acquire the
stock. This trade is likely to be highly successful, as the shares have
a strong tailwind and in subsequent days should head higher. On the day
of the breakout, we want to look for a minimum of 50% higher-than-normal
volume. Breakouts accompanied by 300, 400 or even 500%+ normal volume
are that much more likely to be sustained.
But what about the break of a key support level? Does volume matter?
Many students of technical analysis have heard the maxim that it takes
buying to move a stock up, but a stock can "fall of its own
weight." In other words, when a stock breaks below support, the
volume pattern is secondary to the price pattern.
After studying numerous examples of high versus low volume breaks of
support, my conclusion is that volume on or near the day of the
breakdown definitely is a high probability indicator of future
performance. Take the example of XRAY below. In late July 2002 the stock
began a rally that took it very rapidly from a low near $32 to a
temporary peak at round-number resistance of $40 in under a trading
month.
XRAY then backed off, finding support at $38 for several
days. I have labeled this "#1" in the chart above. The stock
then rallied, hitting a top near $43 in mid-August. By the end of the
month the shares eventually retraced, finding support again at $38 at
point #2. A brief rally in mid-September brought the company up just
over $40, but again XRAY backed off and found support for the third time
at $38 (point #3 in the chart). This showed there was definite buying
interest at $38, marking it off as a key support level.
One more time the stock rallied, hit a double top at $43 in October and
then fell below support on a huge volume day late in the month (point
#4). Note that on this test of support, buyers were fleeing the shares.
Three trading days later, when the stock broke support below $38, volume
was nearly double the normal amount. Within a month, XRAY had retraced
almost to where the move started at $32. The high-volume bar, which was
approximately four times normal daily volume, was an important clue to
the impending decline.
When a stock breaks below support on low volume, however, the
swing trader faces a trickier situation. The chart of J.C. Penney (JCP,
shown below) illustrates this point. Between April and late May of 2003,
the department store chain found support on seven separate occasions
very near the $16.50 level. I have drawn a horizontal support line under
this area. Finally, on the first trading day of July the stock
penetrated well below $16.50 intraday, formed a large hammer candle and
rallied back to close above the key $16.50 level.
In the next three trading days, however, it traded below $16.50, giving
the appearance that it was about to meaningfully break support
and trend significantly lower. Note, however, how volume sharply decreased
on the break of support, showing that sellers were reluctant to part
with their shares at this level.
Such a formation created a strong possibility of what
the technician Wycoff called a "spring." A spring is a
false break below support that is typically resolved by the shares
returning to resistance at the upper end of the trading range. That is
exactly what happened in this case, as by late July, JCP had rallied to
near $19.
The breakout above resistance and the breakdown below support often
produce reliable swing trading setups. However, the volume pattern is as
critical in the breakdown as the breakout. The next time you see a break
below support on lower or equal volume than normal, exercise cautious if
you are thinking of going short. If the shares return to the trading
range, then an upside reversal could be in the making.
Good trading!
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