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BREAKOUTS


The Nasdaq's "Don't Look Back" Breakout

07/15/03 01:01:52 PM
by David Penn

A breakout beyond and test of resistance at a 20-day high signals more upside ahead for the Nasdaq.

Security:   $COMPX
Position:   N/A

In a recent piece for Working-Money.com ("Building a Better Breakout," July 1, 2003), I explained how Donchian channels can help traders and investors find those breakouts that are potentially more powerful and long-lasting than others. Specifically, I pointed to breakouts beyond the upper band of a 20-day price channel that successfully pulled back to and tested that upper band, post-breakout.

The thinking behind this approach is quite straightforward. The topmost band in a price channel represents resistance. The breakout beyond this resistance is the first bullish indication that further price advances may be in the making. But what should be watched for is a pullback that tests that resistance level. If the pullback does not penetrate the old 20-day high, then it is very much likely that the resistance level has become a support level. If this takes place, then it is also likely that prices will not retreat beneath the new support level in the near-term-- hence the term "don't look back" (DLB) breakout.

A virtually perfect market advance in the Nasdaq includes three “Don’t Look Back” breakouts.
Graphic provided by: TradeStation.
 
The Nasdaq, which has been the belle of the bull market ball since mid-March 2003, made a DLB breakout on April 22nd. Moving above resistance at 1432-- a resistance level that had been in place for 21 days-- the Nasdaq closed that day at 1451 and continued to move up for 18 days, reaching a high of about 1553 before a significant pullback struck on May 19th. The next DLB breakout took place about five trading days later on May 27th, with the Nasdaq breaking out above another 20-day high resistance level at 1553. Closing at about 1557 on the breakout day, the Nasdaq soared higher in a short period of time, reaching a high of 1684 on June 6th before pulling back and eventually consolidating between (roughly) 1685 and 1600 for the balance of June.

It is worth noting that this is nearly a picture-perfect bull market. Many commentators have described the "tape" of this market as being the best they had seen since the late 1990s, and following these "Don't Look Back" breakouts explains why this appears to be so. When prices break out above a significant resistance level, pullback and test that level, and then continue to move up, it reflects a great deal of underlying strength and buying interest. Regardless of how much longer this current rally lasts (now in its fifth month), this advance remains instructive for traders and investors who confront nascent bull markets in the future. "Is the rally for real?" If you spot numerous DLB breakouts, then the answer is most likely: yes.

The Nasdaq has experienced a third "Don't Look Back" breakout in early July. This breakout occurred on July 7th as the Nasdaq emerged from a June consolidation/correction period. Clearing resistance at 1686, the Nasdaq closed at about 1721 on the breakout day and, after a relatively shallow, low volume pullback that brought the Nasdaq back to about 1708 on July 10th. Most recently, the Nasdaq was trading around 1765. How high will the Nasdaq go? One guideline would involve an invocation of the swing rule based on the 20-day highs in June and the June lows. Taking the difference between the two (1686 and 1596, respectively) and adding that amount to the value at the 20-day highs suggests a Nasdaq move into the neighborhood of 1776. This is slightly lower than the extents of previous DLB breakouts in this bear market rally-- the late April breakout rallied approximately 120 points before correcting, and the late May breakout rallied approximately 130 points before correcting. Thus, the 1776 level might possibly be a minimum projection for the current breakout.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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