Page 134 - THE MARKET WHISPERER

132 PART 5 - Principles O f Technical Analysis

SMART When a stock breaks out of resistance [1], rises [2], and then
MONEY returns to its breakout price [3], we call the phenomenon a
“retest” – in other words, the stock “tests” and certifies the
resistance that has now turned into support.

Why does resistance become support? For three reasons:

1. Traders like buying stocks that break out through resistance. When a
stock breaks out through resistance [1], they buy it, hoping it will go
up. When to their joy it does rise and creates a new high [2], they’re
sorry they didn’t buy a larger quantity at the outset… Now the stock

is too expensive to make it worth buying more, but they would love

to increase the amount they hold if the stock price would drop to its
breakout figure [3]. When it does, they buy, establishing support [3].
2. Other traders who missed the breakout see that the stock is rising, and
are sorry they missed joining the festivities. They won’t buy the stock
at its peak [2] because it is too costly, but they’re happy to buy it when
it returns to the breakout price [3]. When it does, they buy. Buying
indicates that they support that price: in other words, they establish
support [3].
3. The last ones in on the support list are the “short sellers,” who hoped
that the stock would not rise, but were caught with a stock that hit
new highs [1] and were sorry they did not close the shorts before
the breakout. They lose money, but psychologically they have trouble
admitting their error and closing the short all the way to the high [2]. Of
course they would be delighted if they were given a chance to exit their
short position at the pre-breakout price, that is, buy at that price (we
will explain later how a short is closed by buying). When the stock does

drop down, they will wipe the sweat from their brow, buy, and also be
among those establishing [3] support.

Summary:
If a stock drops back down to its “retest” point [3], then all the traders

have a common interest: to buy. This shared interest is what turns

resistance into support.