Trendline breaks can be a lucrative way of entering a stock ready to move rapidly in your favor. Just watch that you don’t get trapped into a fake breakout.
Here’s what a fakeout looks like
After drawing a line underneath the July and August lows for Celestica, you wait for the stock price to break down below the up sloping trendline.
Keep in mind that an up sloping trendline goes below the lows, while a down sloping trendline goes above the highs.
In early September (1), Celestica traded and closed below the trendline. Normally, one would consider selling short on a trendline break to the downside.
In this case, CLS did not follow through immediately. A valid trendline break should be decisive. The stock should move quickly in the intended direction. If it doesn’t . well, it’s better to exit the position and wait for another opportunity.
Notice the next trendline break (2). The day following the break, the stock continued down decisively.
What would you do?
Here’s what CLS looks like as of November 8th, 2002.
The stock looks like it is ready to repeat the previous breakdown. If the stock trades below the Friday low AND closes down for the day, then it’s probably a valid trendline break.
Time will tell if this is the real deal. Traders will wait until the stock trades below the Friday low before taking a short position.
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