Email of the day - on predicting in which direction a breakout will take
Comment of the Day

July 12 2019

Commentary by Eoin Treacy

Email of the day - on predicting in which direction a breakout will take

Hoping for a quick refresher, please. The Chart Seminar reinforces that stocks are either trending or ranging. What I am interested in are the indicators which may suggest a stock could breakout of its range (to the upside or downside) in the near term. Thanks for a wonderful service.

Eoin Treacy's view

Thank you for this question which others may have an interest in. Markets either trend or range so every range is following by a breakout and vice versa. Ranges are explosions waiting to happen because ranges and boring relative to the trending phases. That means expectations for future potential deteriorate at just the same time that energy is being stored up for the next breakout.

When we think about what direction that breakout is likely to take the benefit of the doubt can be given to the prevailing trend. It a reasonably consistent trend is evident then we can anticipate it will continue to range and trend higher until something happens to the relationship between supply and demand to change the underlying environment.

We can also look at commonality. We all other instruments in a sector, market or asset class are performing it makes it more likely the next breakout will occur in the primary direction of trade.

We can also look at the internal dynamics of the range. Is the market rising or falling faster inside the range? In what direction was the most recent dynamic move inside the range?

We can then also think about relative strength. When an instrument is among the better performers in the market it automatically attracts additional interest by an increase in weighting in the Index and the drive to outperform among investment managers. As valuations increase that also creates desire for the next big thing or undervalued asset class to follow on the upside.

We can also think about leadership. Relative strength is about performance but leadership is about timing. It refers to shares of assets that move ahead of a wider move in the market. Generally speaking, the health of bank is a necessary condition for a bull market although central banks have taken over that liquidity provision role in this cycle. We can however see that the Bombay banks Index generally breaks out before the wider India market. Small caps also tend to be leaders and break out early. That is particularly true of the 2nd Section Index in Japan. High yield spreads reflect stress or comfort in the credit markets. Credit very often leads equities.

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