When learning day trading, you will encounter the idea early on that “stocks that break above the previous day’s high are strong.” In fact, many stocks continue to rise after exceeding the previous day’s high, and it is one of the first patterns beginners learn. However, a stock that breaks above the previous day’s high does not necessarily rise. It is not uncommon for a stock to be pushed back immediately after the breakout and actually decline.
In this article, we will organize for beginners why stocks that break above the previous day’s high attract attention, and why price movements diverge after the breakout.
Why the previous day’s high attracts attention
The previous day’s high is the price that many participants recognized as “the price it reached” the day before. It is easily displayed on screens and is conscious to many people. Therefore, orders from both those who want to sell and those who want to buy tend to gather near this price.
People who bought at a high price the day before and are holding unrealized losses think they want to let go if the price returns to that level. On the other hand, some people see it as strong if it exceeds that price and buy it anew. Because orders from both sides gather, the previous day’s high becomes a place of battle.
Breaking through is not proof of strength, but just the beginning
The fact that a stock broke above the previous day’s high indicates that buying temporarily outweighed selling. However, whether that will continue cannot be known without watching the movement after the breakout.
What beginners often do is jump in the moment it breaks through. While it may look like there is momentum immediately after the breakout, selling to lock in profits is also likely to occur. It is better to think of the moment of the breakout as the beginning of confirmation, not the result.
Three movements that occur after a breakout
Movements after breaking above the previous day’s high can be roughly divided into three types.
The first is a movement where the rise continues as is. The breakout price turns into support, and buying continues to enter. The second is a movement where it pulls back once, stops near the previous day’s high, and then rises again. The third is a movement where it is pushed back immediately after the breakout and returns below the previous day’s high, which is called a so-called fakeout.
Which movement will occur is unknown at the time of the breakout. That is precisely why it is necessary to judge by looking at the situation after the breakout.
Does the breakout price turn into support?
In a strong breakout, the previous day’s high that was broken now functions as support for the downside. When it pulls back, the decline stops near the previous day’s high, and buying returns. This movement is seen as a sign that the breakout is valid, in the sense that the former ceiling has turned into a floor.
Conversely, if it falls below the previous day’s high, the breakout itself is negated. Since the possibility that it was a fakeout increases, it also serves as a guideline for stop-loss if you had entered.
What volume tells you
The volume at the moment of the breakout is also an important clue. If it breaks through while volume is increasing, many participants are moving to buy. If it breaks through while volume is low, it may not continue because the price moved with few orders.
Also, watch whether volume is maintained after the breakout. If volume suddenly thins out, it is a sign that buying is not continuing. By looking at volume in conjunction with price movement, the quality of the breakout becomes easier to understand.
Pay attention to the size of the breakout range as well
Whether it only slightly exceeded the previous day’s high or clearly exceeded it and moved away is also a clue. If it only slightly exceeded it, it can easily return with a little selling. If it moves away to some extent and the price is maintained above that, the certainty of the breakout increases.
However, if you jump in after it has moved too far away, your stop-loss position will be too far. You want to be conscious of the balance between the breakout width and the distance to your entry point.
The meaning changes depending on the time of day
Even for the same breakout of the previous day’s high, the implications change depending on the time of day. Immediately after the market opens, there are many participants, and strong breakouts are more likely to occur. On the other hand, because price movements are volatile, there are also many false breakouts.
As time progresses toward noon, the number of participants decreases, and even if a breakout occurs, it may not continue. In the time zone close to the market close, trading for position squaring increases, making price movements harder to read. You want to evaluate the meaning of the breakout based on the characteristics of each time zone.
The situation of the entire market also has an impact
Even if an individual stock breaks above the previous day’s high, if the entire market is falling on that day, the rise is unlikely to continue. Conversely, on days when the entire market is strong, breakouts tend to be more successful.
If you make it a habit to check the movements of the entire market, such as Nikkei 225 futures, your individual judgments will become more stable. If you only look at the movements of individual stocks, it is easy to overlook the influence of the overall market.
Thinking in a hypothetical scenario
The following is a hypothetical example to illustrate the way of thinking.
A certain stock exceeded the previous day’s high after the market opened. A beginner wanted to jump in immediately, but decided to watch the movement after the breakout. Trading volume was increasing, and even after pulling back once, it stopped slightly above the previous day’s high and began to rise again.
In this scene, it was possible to confirm that the breakout price had turned into support. Because I entered after confirming this, I was able to place the stop-loss position slightly below the previous day’s high. On the other hand, on another day, trading volume did not increase immediately after the breakout, and it quickly returned below the previous day’s high. In this case, by not entering, I was able to avoid a loss.
Decide the stop-loss position first
If you are going to enter a stock that has broken above the previous day’s high, decide on the stop-loss position first. A method of placing it slightly below the previous day’s high is easy to understand. If it falls below that, consider that the breakout has been invalidated and let it go.
If you enter without deciding on a stop-loss position, when you encounter a false breakout, your losses will continue to expand. The more a scene looks strong, the more defensive preparation is required.
Also, even if the stock rises after you pass on it, it does not necessarily mean your judgment was wrong. The fact that you passed on it because the conditions were not met becomes the basis for your judgment.
Summary
A stock that has broken above the previous day’s high is the beginning of a strong movement, but there is no guarantee that it will continue to rise. It is important to check whether the previous day’s high turns into support after the breakout, whether trading volume is maintained, and whether the entire market has not collapsed.
Instead of jumping in the moment it breaks out, observe the situation after the breakout and make a judgment. Decide on the stop-loss position first, and if the conditions are not met, pass on it. This attitude is the basis for dealing with breakouts of the previous day’s high.
※This article is intended for general information and sharing market perspectives, and does not recommend buying or selling any specific stock. Please make investment decisions at your own responsibility.
