Sunday, September 18, 2016

Buying 'Breakout' Vs buying 'Near Support'

It has always been tough to decide on entry point in a stock. We know stocks keep giving us entry opportunities to enter. It is up to us where to grab the price. In this article we shall discuss about what are the pros and cons of each of the entry type as mentioned in the title of the article.

A stock looks very attractive on charts while moving up. It gives us feeling of making some quick bucks. At the same time a stock moving down is like a bad dream and we do not wish to touch it. However something which is falling means you are getting it at a cheaper price.

Let me first clarify with one example each as to what I mean by 'buying a breakout' and 'buying near support'

Here are some characteristics of a breakout. A breakout is an action where stock moves beyond substantial Resistance. A sudden demand is created. Whole world starts buying the stock. There is a sudden jump in the stock price. Long green candles are seen on chart. Volume suddenly increases. In fundamental analysis parlance breakout investing can be compared with 'Growth Investing'. It is like buying something though it is costly, as the demand is still high. When I refer it in context of technical analysis, I mean the stock has already seen a substantial run-up, still I wish to buy it as there is further scope for it to move up.
This is how a breakout chart looks like-

Near Support: Here are some characteristics of a stock being near support. In this case stock is in the process of approaching substantial support. Demand is not evident on chart. Volumes are not indicative. Candlesticks still give no clue about potential future up move. This can be compared with Value investing in fundamental analysis parlance. When I refer it in context of technical analysis, I mean stock has seen a substantial fall and there is no indication of buyers interest in the stock, still I wish to buy it due to its low price and potential up move from the level.
This is how a stock near support looks like-

   Having seen what I mean by Breakout and Near support, now lets try and understand what are the pros and cons of taking each type of entry.

Pros and Cons of Entering a Stock on Breakout:
  • We enter during price in momentum. Hence it has higher probability of continuing the upward movement.
  • Less Wait. We don't have to wait for price to start moving in desired direction.
  • Probable time to reach target is less, so some quick bucks can be made.
  • Easier to identify the stock as the stock is in news and found in most Stock Screeners
  • Higher confidence as you are with others who are also buying the stock.
  • Stoploss is far from the entry, hence higher is the risk
  • Breakout can fail thereby giving you higher losses
  • You buy something which is costlier
Pros and Cons of Entering Near a Support:
  • You Enter near support and hence the stoploss is very near.
  • Risk is less as you enter near a stoploss. Reward usually has better ratio with Risk.
  • You buy something which is cheap.
  • There is high probability that the institutional investors are buying these levels.
  • If you know how to identify a good support- you have higher confidence
  • Less probability of a stock moving below support
  • Momentum is still downward, hence entry with low confidence
  • Long wait before the price starts moving up as there is high chance that the stock will consolidate near support.
  • Not found on most Stock Screeners
  • Probable time to reach target is usually higher
  • More 'unknown' factor
Both the cases have some Pros and some Cons. Its an individual's choice which one to enter. Each trader has his way and style of trading. Some like fast results and some other like to have lesser risk. I prefer to have good mix of both the entry types. In my portfolio, I prefer to have around 60% breakouts and 40% entries near support.

Disclaimer: The contents produced here are purely for educational purpose. They should not be construed as buy/sell recommendations. I am not a SEBI registered Analyst or Investment Adviser. Readers are advised to consult their Investment adviser before taking any decisions based on above write-up.