What is a Buy Break
A buy break takes place when a stock makes a move above its previous price levels of resistance. Buying on the break is typically a lucrative trading strategy due to the increased volumes that follow a break as more investors jump onboard.
Breaking Down Buy Break
A buy break is important for technical investors who rely on charts to get a jump on spotting emerging price movement upwards. Most stocks spend extended periods of time trading within a zone of resistance to the upside and downside. The bottom range of a stock’s price is called the support level while the upside price is known as the buy break.
As an example, the stock price of Company ABC has been trading between $34 and $40 per share for the past year. Several times the price has touched the support level of $34 a share and bounced back up to $40, only to settle back down toward the support level. This is an example of a lack of any meaningful momentum in the stock price. As soon as traders see the price go above the $40 price per share, they will pay close attention to see if this looks like a sustained move upwards. Buying soon after the break occurs can be highly profitable, as the $40 share price now becomes the new bottom support level, with a high breakout created at the $50 share price.
Investors who spot early-stage trend shifts can reap disproportionate rewards due to what’s known as the herd mentality. The herd mentality describes the human inclination to follow a trend instead of lead or create trends. The old adage applies here that “a trend is gone as soon as you can spot it.” Chart traders use a variety of techniques to help them be among the first to spot an emerging stock move upwards, as well as to sell shares when the trend reversal begins.
When a Buy Break is Actually a Fakeout
Spotting a true buy break requires the use of a combination of technical tools to be certain that an actual breakout is underway and not what is known as a fakeout. One type of fakeout that can be very painful happens when a stock price opens above the top zone of resistance only to turn downwards and break below the bottom support level in that same day.
Breakouts are further complicated due to the likelihood that volatility in the stock price will increase following the first sign of a breakout as more traders get involved in determining the next move for the stock.
The best way to avoid being fooled by a buy break that is actually a fakeout is to use a combination of charts, ideally at least three, plus information on the stock’s fundamentals to have as much conclusive evidence on hand before buying. Technical traders are always looking for confirmation on a chart before putting money on the line.