What is a Breakdown in Stocks?

What is a Breakdown in Stocks?

A breakdown in stocks is a bearish formation where a security closes below a support level with increased volume.  This drop in price is categorized as a bearish development and is a tool for both technical analysts and value investors. 

How to Identify a Breakdown

Sizing up a breakdown is truly a judgmental call, like everything else in the stock market.  A trader will first have to identify their primary trading time frame.  Next the trader needs to pinpoint significant price levels which have a number of tests.  This can be in the form of a horizontal support level or a strong uptrend line.  Once the stock closes below the support level with increased volume, this is the first sign that a breakdown has begun.  A trader should wait for confirmation by the stock closing below the breakout candlestick, which implies there is more room to the downside.

Trading Breakdowns

Breakdowns are a favorite amongst short sellers.  Short sellers are able to jump on board these moves to make quick gains as stocks fall much faster than they rise.  Breakdowns are also used as an opportunity to exit losing long positions. 

Breakdown Chart Examples

Breakdown through an Uptrend

Below is an example of a break in an uptrend for Bidu.  Notice how the stock had one final push up where it was unable to make a new high before breaking down through the 6-month uptrend line.

Breakdown through Uptrend Line

Breakdown through a Horizontal Support Level

Breakdowns through horizontal support can produce some of the most vicious sell offs, as a result of the back forth action preceding the break.  This leads to the pickup in volume that is consistent with breakdowns.  Below is a chart example of NEM after it broke down through horizontal support at $35.  Notice how the stock quickly experienced a 20% decline.

Breakdown through Horizontal Support
Tim Ord
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Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...

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