Drawing resistance levels on a chart is easy. Any novice trader can do it. 

Simply look for the spots where the stock has previously topped out, and draw a line connecting
Them.

Use this tool to find the best setups

To the random person looking over your shoulder at Starbucks, you might look like a genius.

But every other trader out there has drawn those exact same lines.

And for that reason, those lines often become self-fulfilling prophecies. 

The fact everybody has the same levels marked on their charts can be all it takes to create real resistance or support for a stock.

So those lines are useful, but simply identifying the previous resistance levels on a chart won’t give you an edge over other traders. 

Understanding how and why resistance levels form is what will separate you from the pack.

Because not all resistance lines are made equally. 

There’s one type in particular that I look for when trying to identify breakout trades.

My #1 indicator that a stock is ready to move.

How Resistance Levels Form 

A lot of times, resistance comes from memory. Traders remember where the stock topped last time and sell into that price expecting it to stop there again. 

Then there’s the levels where people have previously taken gains, ringing the register at round numbers and old highs.

Then there’s stock that somebody has to move.

A shelf offering, warrants converting, an insider selling into strength, or a fund working a big position out across a range of prices instead of dumping it at market and tanking its own exit.

Those sellers will stop a stock cold, and none of them show up on a chart. You learn about them when the breakout you just bought goes nowhere.

The one resistance level you can find yourself, before you put money down is the price where a crowd of previous buyers are stuck.

Identifying The Trapped Crowd

Let’s say a stock runs to $10 on enormous volume and closes the day back at $7.

Anyone that held into the close is now waiting patiently for the stock to climb back to their break-even level. (or if they’re greedy, even farther than that)

So every time the stock climbs back toward $10, the same people are there selling into it again.

To get above $10, buyers have to take every share those people are trying to sell.

If the stock breaks through that level, it tells you there’s real momentum building behind the move. These are the levels we watch for a breakout trade..

I start with volume. Going back a few weeks, I want the day with a massive spike, way beyond what the stock normally trades.

Then I look at the what the price did on that same day. I want a big run up that closed well below the high.

The volume spike says a lot of people bought. The close well off the high says most of them ended the day underwater.

Then I find where the stock stalled on the way back up. That price is the ceiling where the trapped crowd is waiting to sell.

That’s the level I’m watching for a breakout.

Cypherpunk Technologies Inc. (NASDAQ: CYPH) did exactly that on August 24. 

It traded 38.6 million shares, the heaviest day on its chart going back to March, and ran as high as $2.02, before it closed at $1.68.

Over the next two weeks it pushed up to $1.84 or higher and closed back under three separate times. Same crowd, getting out.

Then on September 3, CYPH broke through that crowd of sellers and didn’t look back.

It kept climbing for four more sessions.

The stock has since fallen back to the $2.50 range.  But anyone who bought the breakout at $1.85 had plenty of opportunity to lock in gains.

If you knew how to spot the trapped crowd, this was an easy breakout trade.

Not every stock has a ceiling with a trapped crowd sitting above it. But it only takes a few minutes with the chart to find out if it does.

That’s the step most traders never take when drawing their lines.  The ones that do have a way better chance of getting paid on names like CYPH.

Stay sharp,

Jack Kellogg

*Past performance does not indicate future results