A breakdown is a sustained move below a support level. Breakdowns are usually associated with a bearish outlook and might be triggers for sizable moves to the downside. A key factor in the analysis of a breakdown is whether it has been confirmed or not.
If a support line is penetrated by a significant amount, or the price stays below this line for a prolonged period of time, we can speak of a breakdown. The support line becomes a resistance line, i.e. a line off which the price is more likely to bounce than to cross it from below – it is a concept contrary to the one of support. The same psychological factors (such as grief and regret) as in the formation of support play an important role in this case.
Breakdown in Gold
If such a scenario takes place in the gold market, we can speak of a breakdown in gold. An example of the above that also presents a situation in which a support line becoming a resistance line is shown below.
In the period 2009-2011, after the liquidity-driven slump of 2008, gold enjoyed a very strong uptrend. 2011 turned out to be the final top of the 2000/2001-2011 bull market. If we draw a support line based on the 2009-2011 local bottoms, then we see that this line was broken to the downside in 2012. Even the 2012 rally did not bring gold above the 2011 top, let alone the uptrend. As it turned out, the 2012 breakdown after the 2011 top was the end of the 2011 rally and the whole 2000/2001-2011 bull market.
Breakdown in Silver
The white metal usually correlates with gold. This means that we would expect breakdowns to work for silver similar to the way they work for gold.
The support line based on the 2008 and 2010 bottoms establishes a long-term trend for silver. In 2011, when the white metal topped, it reversed toward this line. Following the initial strong pullback to the line, we saw period of indecisive action around it. The confirmation came no sooner than in 2012. This is in line with what we saw in the gold market and the meaning might be that the two signals reinforced one another. Bear in mind that this particular breakdown was of a long-term nature – it was not necessarily a sign for the short term and there indeed was a period between the initial breakdown below this support line and the confirmation, and this period lasted more than half a year. But when the silver breakdown was confirmed, what a move down it became!
Breakdown in Mining Stocks
Can we take an even more long-term-oriented approach to detecting major bottoms? It turns out we can, and mining stocks are one example of that.
This is a very long-term chart, where the support line is based on the 2000 long-term bottom which was the starting point for the bull market and the 2008 local bottom which was the most important move down during the bull market. Through this lens, the breakdown below the support line did not occur until the first half of 2013. But once it did and was confirmed, the HUI Index (a proxy for gold stocks) went from about 250 to around 100. Even assuming that one could not have caught the whole move, there’s enough wiggle room left for significant profits.
Verification of a Breakdown
In order to consider a violation of a support line valid, at least one of the criteria listed below should be met:
- The move below the support line should be significant. There is no clear rule telling what constitutes a significant move. Some use 3% as a benchmark in the case of important support levels and 1 % for the short-term ones.
- It should be accompanied by high volume.
- Price should close below the support level for 3 consecutive trading days to confirm the breakout .
The idea of a breakdown is a fundamental one in technical analysis. It can be very useful in making investment decisions as it allows a trader or an investor to take advantage of certain market moves.