Trading stocks education - Trading tactics & examples

Downside Breakouts


Let's consider the downside breakout of natural gas distributor Enron (ENE). Once considered a broadband play because of its foray into the Internet infrastructure business, Enron fell on hard times in February of 2001. Indeed, during the span of just seven months the stock had two noteworthy downside breakouts.

courtesy of Bedford & Associates Research Group Inc

During December 2000 through the early part of March 2001 Enron was mired in a large wedge formation. The stock had lows at $65, $66 and $67.50 in December, January and March respectively. The top part of the wedge was defined by highs at $83.50, $82.50 and $81.75 in December, January and February respectively. The downside breakout occurred in early March at $67.50 amid very subdued volume. Despite this the stock sank to $52 in less than two weeks and it was not until volume increased that the decline subsided. The second wedge began with the $52 low in the middle of March. After several tests of that support level, Enron shares fell through $52 in the early part of June. Once again, volume was relatively light but this downside breakout ultimately led to a decline that would see the Enron shares sink to less than $35 just a week later.

Conclusion

• Generally, volume follows trend, that is in a rising trend volume should expand on rallies and contract on declines. In falling trends volume should expand on declines and contract on rallies.
• When volume contracts after an extended rally, or expands sharply after an extended decline a dramatic reversal will normally transpire.
• Volume and volatility contract in consolidation patterns because investors cannot reach consensus, they are undecided.
• Volume should expand significantly for upside breakouts. If volume does not expand the breakout is considered illegitimate.
• Volume may not expand for a downside breakout because falling share prices cause demoralization and inactivity among stockholders. During such circumstances, fewer shares are required to drive prices lower.

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