Understanding Market Behaviors

Remember the last time you went on vacation? After locking the door and heading toward your car, you likely turned back abruptly to ensure the lock was secure before continuing your journey.

Financial markets, driven by human emotions, exhibit similar behaviors. After a convincing move beyond a long-held resistance, assets typically return to confirm the validity of the breakout. This serves as a test of the strength of the former resistance-turned-support, after which larger rallies may unfold.

The Breakout and Retest Play

The “breakout and retest play” phenomenon is well-known across asset classes. Bitcoin’s (BTC) ongoing sell-off might be just that—a healthy retest of the breakout point or the former resistance-turned-support of $73,835 breached in November.

In simpler terms, the downward momentum could lose steam at or near these levels, potentially setting the stage for a bigger rally.

BTC’s Recent Performance

BTC has dropped over 15% to under $80,000 this month, testing the former resistance-turned-support at $73,835. Prices broke above that level in early November, following a lengthy consolidation after pro-crypto Donald Trump’s election win.

The tendency for markets to retrace or revisit the breakout point before staging more significant rallies stems from behavioral investing aspects. Investors tend to be risk-averse when securing gains. Consequently, when trading profits arise, traders often book those instead of letting their winning trades continue. The so-called prospect theory explains why post-breakout rallies can stall, leading to a retest of the breakout point. BTC holders have been booking profits around the $100K mark since December.

The Buying Cycle

As prices decline and approach the breakout point, in this case, $73,835, market participants who missed the initial rally typically jump in, ensuring the level holds. The resulting bounce from the former resistance-turned-support attracts more buyers, which could lead to a more substantial rally.

This pattern occurred in both Q3 of 2023 and August-September 2020.

Historical Insights

On both occasions, the breakout and retest led to larger rallies that reached new record highs. However, traders should note that a failed retest or a lack of a meaningful bounce could indicate underlying weakness, potentially leading to a complete downtrend.

Numerous examples over the years show retests of breakouts/breakdowns leading to greater moves in traditional markets. For instance, the yield on the 10-year Japanese government bond triggered a double-bottom breakout in January 2024, revisiting the breakout level multiple times before climbing to multi-year highs.

Likewise, the AUD/USD pair dropped from a major support trendline in December, signaling a deeper decline. It rebounded to trendline resistance early this month but experienced sharp losses this week.

Conclusion

Understanding these market behaviors can provide insights for traders navigating through potential market opportunities and risks.