The Hindu Business Line : Trader's Corner

It is commonly observed that a stock that is trending sideways in a narrow band suddenly shoots out with an upward gap, only to lose all the gains and close well within this band towards the end of the trading day. The sideways move resumes the next day resulting in one bar that juts out of this band.

These bars represent false break-outs and can wreak considerable damage to trading positions. Traders typically avoid stocks that are moving in a lackadaisical manner and wait for it to move above the resistance represented by the upper boundary of the trading range before buying the stock.

Now, consider a day when a security gaps up in the morning to move beyond the resistance level. Traders awaiting such a break-out will rush to buy the stock. Such traders will be left high and dry as the stock reverses during the day to end the day well off the opening levels. Similarly, swing traders could be holding a security with a stop loss placed just below the lower boundary of the trading range. On a day when the security makes a downward false break-out, the stop losses could get triggered.

Such false break-outs can not be used to draw any inference regarding future price movement. They only mean that the bulls or the bears made an attempt to make the stock move out of its range by engineering a big move in the morning. The failure shows that the security is not ready to comply yet. It would be wrong to infer that having failed to move in a certain direction, the stock will now move in the opposite direction. To elucidate, we can not conclude that a false move on the upside will be followed by the stock sliding down and vice versa.

Traders can avoid falling in to the trap laid by these moves by initiating trades only after the security closes beyond a certain resistance or support. Intra-day traders should wait for at least an hour to gauge the strength of the move. False break-outs generally fizzle out within the first half hour of the trading session. — Lokeshwarri S. K.