As popular as it is divisive, a breakout strategy is one of the most frequently used techniques among active investors. The idea is fairly simple -- to identify stocks trading within a narrow band and buy them when they move above this channel or sell when they move below. If a stock moves above the channel, it promises substantial gains for investors.
But critics warn against the risk of timing such a move incorrectly or identifying the wrong breakout level. However, when executed correctly, this strategy can yield lucrative gains, which explains its enduring popularity.
Identifying Breakout Stocks
The essence of this strategy lies in calculating the support and resistance levels of a stock. The lower bound of a stock’s trading channel is its support level and it should be sold as soon as it threatens to fall lower. On the other hand, the ceiling is a stock's breakout level and it can gain substantially if it breaks the resistance level.
When a stock is close to its support level, demand is literally hitting the floor. On the other hand, demand rises when it is breaching its resistance level, signaling the right time to make a lucrative addition to your portfolio. The idea is to pick stocks which have just broken above their resistance barriers or are very closing to doing so.
Checking Whether It’s for Real
Stocks that have breached their resistance levels should ideally be in high demand among traders. But the test of whether this is a genuine breakout is when they go on to attain higher prices and the old barrier becomes a new support. This is why it is important to determine whether a long-term price trend is about to emerge.
Only a study of long-term trends can determine whether the existing trading channel has been breached effectively. This indicates the strength of the support or resistance levels. If you can identify the effective channel for a stock, picking it even at a not-so-reasonable price would give you significant returns.
• 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.)
• 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 over 7848 stocks to only 14.
Here are the top five stocks that meet these criteria:
Golden Star Resources Ltd. (GSS - Free Report) is an un-hedged gold producer which owns the Wassa gold project in Ghana and controls a number of gold exploration properties in West Africa. Its expected earnings growth for the current year is 50%. Golden Star Resources carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Datawatch Corporation (DWCH - Free Report) is a provider of Enterprise Reporting, Report Mining and Service Center software products that help organizations increase productivity, reduce costs and gain competitive advantages. Datawatch has a Zacks Rank #2 (Buy) and its expected earnings growth for the current year is 97%.
AeroCentury Corp. (ACY - Free Report) is an operating lessor and finance company which specializes in leasing used turboprop aircraft and engines. AeroCentury has a Zacks Rank #2 and its expected earnings growth for the current year is 13.5%.
Crown Crafts, Inc. (CRWS - Free Report) operates, both directly and indirectly through its subsidiaries, in two principal business segments within the textile industry: Adult Home Furnishing and Juvenile Products, and Infant Products. Crown Crafts has a Zacks Rank #2 and its expected earnings growth for the current year is 9.1%.
Tilly's, Inc. (TLYS - Free Report) is a specialty retailer in the action sports industry selling clothing, shoes and accessories. Tilly's has a Zacks Rank #2 and its expected earnings growth for the current year is 19.7%.
You can get the rest of the stocks meeting these criteria by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and backtest them first before taking the investment plunge.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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