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June 26, 2004
Expect a test of support at 10300. If that fails we are likely to see a test of the primary 10000 support level. If that fails ... well, then we have a reversal of the primary trend, but this is not yet a high probability.
Twiggs Money Flow (not shown), however, continues to signal distribution.
Twiggs Money Flow continues to signal distribution.
The yield on 10-year treasury notes is consolidating above support at 4.50%. The Fed is expected to raise interest rates by a quarter percent at its Wednesday meeting. A healthy yield differential (10-year T-notes minus 13-week T-bills) of 3.4% reflects imminent rates rises.
New York: Spot gold closed up at $402.10, above the previous high and confirming an intermediate up-trend. Expect a test of resistance at the April high of 427.25.
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Expect continued selling until the end of the June 30 financial year as fund managers bury their dead (sell off non-performing stocks that they do not want to appear in their balance sheets) and private investors realize capital losses.
Twiggs Money Flow signals strong accumulation.
Trading breakouts can be a hazardous business, mainly because of the large number of false breakout signals. A typical example would be the aptly-named GAP Inc. (The Greater Atlantic and Pacific Tea Company - NYSE) charted below. I counted 20 false breakouts over a 10-year period (and there are probably more if you examine the chart closely). GAP is one of a minority of stocks where there has been no financial restructuring requiring dilution adjustments, making it fairly easy to identify historic support and resistance levels (at round numbers).
To explain the cause of false breaks (or false catapults as they were referred to in some of the early literature) let us first re-visit the basics:
A trend that goes straight up without any major corrections or consolidations (a spike) will be prone to failure. The higher that price climbs, the more anxious stock-holders become about locking in their profits: buying support has not been tested. Fearing a major correction, many will join the ranks of sellers at the first signs of a reversal. And fear is a powerful motivator: the further price falls, the more sellers will be panicked into selling, until the devil takes the hindmost.
A consolidation or correction has the opposite effect: it instills confidence in stock-holders. Higher prices are tested by sellers and buyers commitment is proven, establishing a solid base for further gains.
Support and resistance at these consolidations are not the brick walls that some would have us believe. They can be fairly elastic: absorbing the energy of a rally or correction before returning to their original position. Rather like the strings of a tennis racket. We may see several forays across a line of support or resistance, all of which are repulsed, before sufficient energy is accumulated to break through.
Some of these forays are initiated by professional (short-term) traders in attempt to shake out stop-losses and accumulate a position at lower prices. Brokers also stand to benefit from the additional brokerage when buy-stops are triggered as price breaks through a major resistance level. And they get a second bite at your trading capital when price retreats, triggering stop-losses.
Placing wider stops, below the opposite border of the consolidation pattern, does not always help. And when your stops are triggered, the losses will be far more expensive.
A false break is likely to be followed by a test of the opposite border of the consolidation pattern - and you may face a similar situation there as well. See  and  on the chart below.
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