Choosing breakout stocks is probably one of the most popular techniques used by active investors. The logic behind this strategy for stock selection is to identify stocks trading within a narrow band. Such stocks are to be purchased as soon as they move above this channel and are sold when they fall below. In case a stock moves above this band, it usually gains momentum.
However, market watchers often caution against timing such a move incorrectly. This is because there is a significant risk of identifying stock movements as breakouts, even when this is not the case. At the same time, when utilized correctly, this strategy yields substantive gains, which is the reason for its enduring popularity.
Determining Breakout Levels
The first step to selecting the right breakout stock is to calculate its support and resistance level. A support level is the lower bound for stock movements while a resistance level refers to the maximum price which it trades within over a considerable period.
In other words, the demand for a stock is at its lowest at its support level, which means most traders are willing to sell it. At the resistance level, most traders are willing to go long on the stock, which means that they would like to add them to their portfolios. The key to identifying breakout stocks is to zero in on those that are on the verge of a breakout or those that have just broken above the resistance level.
Has a Genuine Breakout Occurred?
The primary risk associated with such a strategy is that the decision to buy an apparent breakout candidate has been incorrectly timed. When a stock moves above the resistance level, it should be a highly prized commodity for traders. However, whether such a breakout is at all genuine is another matter altogether.
For a bona fide breakout, the stock’s earlier resistance barrier should become its new support level. This only happens if the trading channel that has been established is tested by observing long-term price trends. The strength of the support and resistance levels can be ascertained only through such a study. Despite the risk of misidentification, correctly identifying such stocks can yield considerable returns, even at a price which may not seem attractive at first glance.
Percentage price change over four weeks between 10% and 20% (Stocks which are showing considerable price increases, but whose gains are not excessive.)
Current Price /52-Week High greater than or equal to 0.9 (Stocks which are trading 90% close to their 52-week highs.)
Zacks Rank less than or equal to #2 (Only Strong Buy and Buy rated stocks can get through.)
No matter whether the market is good or bad, stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have a proven history of outperformance. You can see
. the complete list of today’s Zacks #1 Rank stocks here
Beta for 60 months less than or equal to 2
(Stocks which move by a greater degree than the broader market but within a reasonable limit.)
Current price less than or equal to $20 (Stocks which are reasonably priced.)
These criteria narrow down the universe of more than 6,861 stocks to only 25.
Here are four of the 25 stocks that passed the screen, each carrying a Zacks Rank #2:
Energy Recovery, Inc. ( ERII Quick Quote ERII - Free Report) is a designer and manufacturer of various solutions for industrial fluid flow markets. The company’s expected earnings growth for the current year is more than 100%. PRGX Global, Inc. is a provider of recovery audit services to businesses having payment transactions and procurement environments. The company’s expected earnings growth for the current year is more than 100%. Flex Ltd. ( FLEX Quick Quote FLEX - Free Report) is a provider of design, engineering, manufacturing, and supply chain services and solutions to original equipment manufacturers. It has expected earnings growth of 2.4% for the current year. Marten Transport, Ltd. ( MRTN Quick Quote MRTN - Free Report) is the owner and operator of a temperature-sensitive truckload carrier for shippers in the United States, Canada, and Mexico. The company’s expected earnings growth for the current year is 10.4%.
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Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance .