Invest and Trade Profitably with Jon Johnson

In your comments on a prior play you said your favorite entry point is the test of the breakout. What are you looking at as the breakout and the test?

August 30, 2000

A test of the breakout often occurs after a stock breaks out of a consolidation or base and moves higher: once the initial move higher peaks, the stock “takes a rest” ideally by coming back to test some short term support such as the 10 or 18 day exponential moving average (this “rest” is actually some profit-taking by short term traders, and is normal behavior). On strong breakouts these support levels often hold, but sometimes a stock on a weaker breakout may test back closer to or actually at the buy point, and even strong stocks have about a 50/50 chance of coming back to test their breakout point. The stronger the move the less likely a full test to the buy point will result, but that is a general rule. Full tests back to a buy point tend to occur more often in weaker markets. And sometimes strong stocks won’t come back for a test at all, but typically most will.

Why are tests of the breakout a favorite entry point? That is because stocks can make their strongest moves after a successful test. As noted above, even the strongest stocks can pull back a bit on some profit-taking after the initial surge, and these are choice for selecting test of the breakout plays. Entry points can be taken as the stock moves off of the support level on strong volume. If we have entered the play on the breakout, we can purchase more positions on the test, or use this entry point for taking initial positions if we missed the breakout.

On breakout tests, look for good price/volume action as the stock tests the buy point, what we call an orderly pullback. This means a steady pullback in price along with a narrow intraday range. We don’t like a stock that jerks back and forth on the pullback showing higher volume, indicating a real fight between the buyers and sellers. Instead we want to see a nice, lazy pullback on low volume, showing few sellers and buyers that are taking a breather. If the stock may trade just below the buy point intraday, as long as it closes above that level on the test and shows good price and volume action, it can still be viable to play, especially if the stock has a good technical base behind it.

Even with the above attributes, we still want to see the buyers actually move in, which means a rise in stock price on strong and rising volume. Not breakout volume, but a good volume surge on the move back up. Average volume would be enough if it has come back on average trade. A rebound off of near support or the breakout point with volume surging is where we can put in another buy. This is an especially good entry point, as noted above, when you miss the original breakout. The test is a great way to get a second chance!

After that another great entry point is that first test of the 10 or 18 day MVA after the stock breaks out and starts its trend higher. This is a great add-to point as it is still early in the move (still a lot of upside) and you already have a good idea of the stocks’ strength. Again you see an orderly pullback, a tap of the 10 or 18 day, and then a move higher on a solid volume increase.

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