Why Support Line Breaks Matter To Investors

by | Sep 6, 2008 | Asset Management, Point and Figure

Suddenly stopping…from Belmar, NJ along the way to NYC.

A question came up recently from a client… “we invested in the stock recently, and it went up nicely at first.  But recently, the stock has started to fall.  I’m not sure if we should close this position out… or should we just hang on.  What do you advise?”

The answer is… “it depends.”

It depends on several factors.  And it depends on the answers to some questions.  Some of the questions include:

  • is this a long-term investment, or a trade?
  • If it is a trade… where is the logical point for a stop loss?
  • if this is a long-term investment… where’s the support line?

When an investment breaks the support line, this is a clear time to take action.  Investments can zigzag up and down — and still remain in long term uptrends, if they don’t break that support line.  But once that line is crossed, the story has now changed.  Instead of an investment that’s heading “northbound” on the Garden State Parkway, you have now crossed over and are heading “southbound.”

This “northbound/southbound” discussion is important to grasp.

Stocks, mutual funds, exchange traded funds… any investment… never move in straight lines.  There will often be times where we have exceptional short-term gains — or exceptional short-term losses — in a long term investment.  But the investment has never broken the support line while we’ve owned it.

Let’s put this in really simple terms: you may start out from the Belmar (or somewhere along the Jersey shore), on your way to New York City.  To get to your destination, you’ll be traveling north on the Garden State Parkway — northbound.  Along the way, you may pull off and visit grandma in Red Bank, NJ.  You may also take a few minutes, pull off an fill up the gas tank, near Hazlet.  Later on, you may stop and get a quick bite to eat, near Woodbridge, New Jersey.  All this is accomplished while you’re heading northbound on the Garden State Parkway, toward Manhattan.

So you’re “trip” from Point A to Point B had several detours along the way.  But you never changed direction — never changed trend.

Now, suppose you wanted to take this trip — but found yourself driving “southbound” on the parkway… toward Atlantic City.  Do you think you’ll be able to reach your destination, if you’re heading the wrong way?

When an investment breaks the support line, it changes direction.  Stocks that are trading above their support line are heading in an upward direction.  Some investments move faster than others.  Once a stock, mutual fund, exchange traded fund — any investment — breaks through that support line, it’s now heading towards Atlantic City, New Jersey.  And, since I am not a gambler, this is not really where I want to go.

Some advisors (and clients) will tell you to place a stop loss order 10% below your purchase price — and then continually nudge up your stop price, as the stock moves up.  10% seems like an arbitrary number.  When it comes trades, I’d like to stack the odds in our favor before entering — finding an opportunity that makes sense for our portfolio, and is close to the support line.  This gives us a much closer (stop point)… if the support line is broken, we leave the investment behind…no excuses.

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