Breakdowns

Breakdowns occur when prices move forcefully below price support on above-average volume. The more significant the prior price support, the more powerful the breakdown will be. Volume and the length of the trading range prior to the move are the two important facets to watch to determine if a breakdown is real. An ideal breakdown has an opening and close beneath price support.

Breakdowns can occur on regular price moves or on gaps. The longer a stock has consolidated (traded in a narrow range on light volume) before the breakdown, the more important the lower move on heavy volume will be. Stocks tend to consolidate immediately

To view this image, please refer to the print version of this book

To view this image, please refer to the print version of this book

To view this image, please refer to the print version of this book above price support for two or three days before breaking below. The more often a stock tests price support, the more bearish that price action becomes. Stocks usually hold price support the second and third times they touch that level. After a stock tests price support more than three times, the chances for a breakdown are better.

Similar to a breakout, the best place to short a breakdown is always after the stock price has pierced through its support zone. Depending on the price of the stock, always provide yourself with an entry buffer zone. (See Chapter 11, Entry, and Chapter 12, Exit.) With a $50 stock, your buffer zone should be about 1/2 point. If this price zone is missed when you attempt to short the stock and the stock moves more than 2i/i percent beneath the breakdown zone and lingers there for a period of time before roaring back to the initial entry zone, leave it alone. It could be a rising star (the opposite of a fallen star), which means that market conditions and sentiment about the stock have changed, and you're better off forgetting about this particular trade.

The chart in Figure 16-4 shows Microsoft (MSFT) breaking down on two separate occasions. The first breakdown occurred on October 15,1999, when prices ratcheted beneath 90, which was price support. After rallying back through that level, MSFT broke down through 90 again on November 8, on negative fundamental news.

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