Sometimes Wall Street pros refer to an event known as a “breakout.” For those unfamiliar with the term, here is what it means and why it matters to investors.
A breakout refers to a pattern in a price chart where the price of a stock (or other traded asset) breaches a previously unbroken level or a level that hasn’t been breached in a long time, says
founder of technical-analysis service AllStarCharts.com. Put simply, the price has “broken out” of a previously defined trading range.
The first part of the pattern starts when a stock rallies to a certain level, but then retreats, Mr. Parets says.
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“What happens is that there is an overwhelming amount of supply at that price level,” he says, meaning investors dump the stock, sending the price lower.
A recent example is
ETF (XLF), which tracks a basket of financial stocks. In 2007, before the financial crisis the ETF reached a then-record price of around $31 a share. It traded lower than that for 12 years and didn’t revisit $31 until late 2019. It retreated once again as the Covid-19 pandemic and lockdowns sent stocks reeling in early 2020. The ETF’s eventual breakout came earlier this year when the price broke through the $31 level. It closed Friday at $37.78.
“The more times a level gets tested, the more likely that a breakout is likely,” Mr. Parets says.
A breakout is considered bullish for investors because after it happens, the price of the stock (or other asset) is expected to continue rising until it reaches another level of overwhelming supply.
“When you see a breakout happening, the risk is well defined, and you think the stock is going higher,” Mr. Parets says.
Mr. Parets sees a breakout coming for crude-oil futures.
Crude futures, trading at nearly $65 a barrel, have hit $66 several times over the past few years, but each time the rally has stalled at that level. The fact that a critical level gets touched more than once makes it likely that the price will breach it sooner or later, Mr. Parets says. And when or if that happens, he expects the price of crude oil to sail far higher.
“We are patient; when you see that break through the $66 level, then the next target is $76,” he says.
Some observers says a breakout can happen when prices drop lower, too. The same principles work in the opposite direction, with a breakout to the downside being a bearish signal.
Mr. Constable is a writer in Edinburgh, Scotland. He can be reached at firstname.lastname@example.org.
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