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High-Probability Trade Setups: A Chartist's Guide to Real-Time Trading by Tim Knight

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Chapter 21

Support Failure

The topic of support failure covers not so much a specific pattern as an event that can take various forms. The general idea is that a stock has, for a certain amount of time, respected a given price level as support. That is, the stock has remained above this level (which may be a specific price or a drawn object on the chart) until, for whatever reason, it breaks beneath this level.

Support failure is a signal to the bulls to get out of their position and a signal to the bears to short the stock or, alternately, buy puts on it.

DEFINITION OF THE PATTERN

There are a couple of general categories of support failure that will be covered in this chapter, and they are different in their appearance but similar in their behavior.

The first is price failure, an example of which is shown in Figure 21.1. Price failure is an instance in which a certain absolute dollar price or a fairly narrow price range has been respected for some length of time as a level under which the stock will not fall. It represents, by definition, a state of equilibrium between buyers and sellers—a stalemate, if you will—at which buyers eventually have regained control.

With the Dow Jones Utility Index example, there was strong support between 330 and 350 on the index. It spent five years above this level, getting as high as about 575, and each time the index sold off, it respected this price range as support. Early in 2008, there was a lot of trading within the price range, and the rally ...

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