Even though support and resistance levels may be fairly constant for a particular stock, they will frequently be 'tested' - in other words, the prices will go right up to the levels to see if they hold firm. At some point a level will be 'penetrated' and there will be a 'breakout'.
In the chart below the 320p support level for Fisons plc was firmly established from late 1989 through to June 1992 and despite being tested it held firm. Then, in June 1992, there was bad news about the company which undermined investor confidence and the share price broke below 320p.
Example
Click here for a full size graph.
'Penetration' of support levels usually requires a fairly dramatic change in the fundamentals of a stock. It may be that the company releases very poor figures, or reduces its dividend, or calls off acquisition talk. But once the support level is breached, the plunge downwards can be severe, as the Fisons example shows.
Note too the importance of volume when watching a support or resistance level being tested. The more volume that accompanies the test, the more likely the level is to be penetrated. The chart below shows Guinness being repeatedly tested at 520p between January 1993 and January 1997. Then in May 1997 the level was tested again, but this time it was accompanied by a significant increase in volume. The resistance level was breached.
Example
Click here for the full size graph.
The other thing to watch out for when there is a breakout is 'Trader's Remorse'. This refers to the situation in which prices return to the old support or resistance levels not long after the price breakout.
The chart below shows how in early 1995, the price of ICI shares broke through their 745p support level. Almost immediately investors felt 'remorse' and the price returned to its old level within a couple of weeks.
Example
Click here for a full size graph.
Usually Traders Remorse is a temporary phenomenon, and the market decides that the new support and resistance levels are in fact acceptable. But occasionally the Remorse sets in and prices stay at their old levels. This can result in a 'bear trap' or a 'bull trap'.
Example
The ICI example was a classic bear trap:
How can you tell if a remorseful period is going to end in a 'trap' or in a new trend being established? The answer, as always, lies in the accompanying volume chart.
| Breakout volume | Remorse volume | Likely result |
|---|---|---|
| High | Low | New trend |
| Normal or low | High | Trap |
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