The Breakout and Retest Play: A Time-Honored Phenomenon in Financial Markets
After a convincing move beyond a long-held resistance, assets often return to confirm the validity of the breakout. This phenomenon is well-documented across various asset classes and can be a significant factor in determining the strength of the former resistance-turned-support.
One of the most notable examples of this phenomenon is the ongoing sell-off in Bitcoin (BTC), which has dropped over 15% to under $80,000 this month, exposing the former resistance-turned-support at $73,835. This level was breached in early November, marking the end of months-long consolidation following the U.S. presidential election.
The breakout and retest play can be attributed to the behavioral aspects of investing. When faced with profits, traders tend to quickly book those gains, rather than allowing the winning trade to run wild. This phenomenon is rooted in prospect theory, which explains why post-breakout rallies often lose steam, leading to a retest of the breakout point. BTC holders have been taking profits around the $100,000 mark since December.
As prices turn lower and near the breakout point, market participants who missed the initial rally will jump in to ensure the level holds. The resulting bounce from the former resistance-turned-support can draw in more buyers, potentially yielding a bigger rally.
This pattern has played out numerous times in traditional markets. For instance, the yield on the 10-year Japanese government bond triggered a double-bottom breakout in January 2024 and revisited the breakout level multiple times before rising to multi-year highs.
In a similar vein, the AUD/USD pair dived out of a major support trendline in December, only to bounce to the trendline resistance early this month, before suffering sharp losses this week.
On both occasions, the breakout and retest produced bigger rallies to new record highs. Traders, however, need to be cautious, as a failed retest or lack of a meaningful bounce can indicate underlying weakness that can evolve into a full-blown downtrend.
Conclusion
In conclusion, the breakout and retest play is a time-honored phenomenon in financial markets, driven by the behavioral aspects of investing. As traders, it is essential to be aware of this pattern and its implications for the markets. By understanding this dynamic, investors can better navigate the complexities of financial markets and make more informed decisions.
FAQs
Q: What is the breakout and retest play?
A: The breakout and retest play is a phenomenon where assets often return to confirm the validity of a previous breakout, before continuing their upward trend.
Q: What drives the breakout and retest play?
A: The behavioral aspects of investing, such as traders’ tendency to book profits quickly, contribute to the breakout and retest play.
Q: Is the breakout and retest play limited to cryptocurrencies?
A: No, the phenomenon is observed across various asset classes, including traditional markets.
Q: What are the implications of a failed retest or lack of a meaningful bounce?
A: A failed retest or lack of a meaningful bounce can indicate underlying weakness, potentially leading to a full-blown downtrend.
