Breakdown: What it is and How it Works(James Chen)

Breakdown: What it is, How it Works, Trading it
By JAMES CHEN

Updated June 30, 2022

Reviewed by GORDON SCOTT

What Is a Breakdown?

A breakdown is a downward move in a security's price, usually through an identified level of support, that portends further declines. A breakdown commonly occurs on heavy volume and the subsequent move lower tends to be quick in duration and severe in magnitude.

KEY TAKEAWAYS

A breakdown is a downward move in a security's price, usually through an identified level of support, that portends further declines.
A breakdown commonly occurs on heavy volume and the subsequent move lower tends to be quick in duration and severe in magnitude.
A breakdown can be identified by traders using technical tools such as moving averages, trendlines, and chart patterns.

Understanding a Breakdown

A breakdown can be identified by traders using technical tools such as moving averages, trendlines and chart patterns. Traders can draw trendlines on a chart that connect several swing lows to find areas where prices may be susceptible to breaking down. Heavy volume should accompany a breakdown below key support levels, which shows participation in the move lower.

Technical traders can either close out any existing long positions or short sell a security when it breaks below a support level, since that is a clear indication that the bears are in control and that additional selling pressure is likely to follow. A breakdown often signals the start of a downtrend.

When a security initially breaks down, traders should seek confirmation from several indicators and other chart time-frames to ensure the move is not a head-fake. For example, a breakdown on a 15-minute chart has a higher probability of continuing lower if the daily and weekly charts are in a downtrend. A breakdown is the bearish counterpart of a breakout. In the chart below, prices have broken down below the neckline of a head and shoulders pattern.

Image by Julie Bang © Investopedia 2019
Contrarian traders may look to trade failed breakdowns.

Trading a Breakdown

Traders could take a short position when the security’s price initially breaks down below major support. To do this, a sell stop-limit order would need to be placed just below the support level. Once prices break down, the decline is likely to be intensified as stop-loss orders for long positions are triggered with additional selling pressure coming from breakdown traders. The extra volatility caused by the breakdown may result in a mediocre fill, due to slippage.

Alternatively, traders can wait for a retracement to enter the market. They could place a limit order where the security’s price initially broke down from; that area has now become a resistance level. Entering the market on a retracement is likely to result in a better fill than trying to catch the breakdown early. The flip side is the security may not retrace back to the trader’s limit price.

Once in a short position, traders could use a trend following indicator, such as a moving average as a trailing stop. For example, when the price of the security closes above the moving average, the trade is exited. If traders believe the breakdown is the start of a new downtrend, they may want to use a longer-term moving average to try and catch the majority of the move.

Linkage

https://www.investopedia.com/terms/b/breakdown.asp?hid=826f547fb8728ecdc720310d73686a3a4a8d78af&did=14612656-20250423&utm_campaign=investopedia-term-of-the-day_newsletter&utm_source=investopedia&utm_medium=email&utm_content=042325&lctg=826f547fb8728ecdc720310d73686a3a4a8d78af&lr_input=46d85c9688b213954fd4854992dbec698a1a7ac5c8caf56baa4d982a9bafde6d

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