Sunday, January 21, 2007

False Breakout: COGN

On Monday I pointed to a nice looking setup taking place in COGN, as it had cleanly broke through resistance. However, what happened next is what is known as a "false breakout". The stock quickly sunk back below resistance.

On the chart below, I have placed a vertical line where the breakout occurred. Notice that RSI gave a higher reading during its November highs. I had noticed this negative divergence, which is why I decided against entry.

Now the stock is setting up on the short side. When I see a false breakout at new highs that occurs where there is negative RSI divergence, I like to enter on the short side when the stock breaks below the previous highs. Here, the new highs occurred at $40 (not shown on this chart, but the stock reached $40 in April). If we see a break below that level, it would be a good time to short. The 50 day moving average may also provide a good short entry level (although I've yet to test this type of moving average setup).

I would not play this trade aggressively by shorting early. We still don't know if this is an orderly pullback or a move down (at least I don't). RSI and the false breakout point towards a breakdown, but not technical barriers have been broken just yet.

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