Monday, September 7, 2009

Should we trust this breakout

The underlying theme in many comments by experts and novices is: The Nifty did break out above 4740 today, but can we trust this breakout?

Now, there can be many reasons for saying that the breakout from this four month trading range may well be false. Yet, the only way to find out if the breakout is genuine is to wait for the follow through. If the Nifty holds support then this is genuine, if it breaks down then the breakout was false. There may also be some early warning methods but the only sure way is to wait and find out! But this may not be a good idea since by the time we realize that this is a genuine breakout, the Nifty could be well over 5000.

My point is: The point of any breakout is the point of maximum risk. If the breakout is false then you have bought at the highest point in the move. There are two ways of trading a breakout - (1) Buy at the point of breakout (2) Buy on a pullback after the initial breakout. Both methods are correct. Traders may use one or a mix of both methods.

The width of the trading range was 400 points - 4350 to 4750. Thus, a possible target is 5150 for the Nifty. Will this be achieved? Again, we cannot say. But, until proved otherwise, we will go with the breakout.
Cheers.

3 comments:

Ashish said...

Excellent... but what about stop losses in both the scenarios you mentioned? For the given levels on possible target 5150, could you please comment on your revised stoplosses and at the same time justify the stop loss levels?

men said...

Mr. Sudarshan, I read somewhere that a BREAKOUT occurs with a lot of volatility and with good volumes, if the above is true BOTH WERE missing on Monday. The article says this could also be a range expansion. Also some illiquid stocks which have fallen 90% are making new 52 week highs, what is to be done if we have such stocks?
Also congratulations to you your 3 stocks infosys/orchid (reached your target of 136) yesterday and jspl have really worked, my only doubt was they took some time, jspl retraced a little after you suggested a buy here.

Student Of Market said...

A possible short answer to the question

"should we trust this breakout" in my mind is the following:

Trust but verify.

In other words, participate in the break out but have clear exit point for at least part of your positions, should you determine later that it is a false one.