Seeking out breakout stocks is probably one of the most favored techniques among active investors. The logic behind this kind of stock selection is to determine which stocks are trading within a narrow band. These stocks are to be bought as soon as they move above this channel and sold when they fall below. In case a stock moves above this band, it usually gains momentum.
At the same time, market watchers warn against incorrectly timing such a move. This is because there is a significant risk of identifying stock movements as breakouts even when this is not the case. However, when utilized judiciously, this strategy yields formidable gains, which is the reason why it remains popular.
Spotting a Breakout Stock
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 genuine 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.)
• 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 7658 stocks to only 5.
Rent-A-Center, Inc. (RCII - Free Report) is the largest rent-to-own operator in the United States offering durable goods such as consumer electronics, appliances, computers, furniture and accessories.
Its expected earnings growth for the current year is 92.2%. Rent-A-Center has a Zacks Rank #1.You can see the complete list of today’s Zacks #1 Rank stocks here.
BioDelivery Sciences International, Inc. (BDSI - Free Report) is a specialty pharmaceutical company focused on the development and commercialization of treatments in the areas of pain management and drug addiction. BioDelivery Sciences has a Zacks Rank #2 (Buy) and its expected earnings growth for the current year is 63.5%.
Seabridge Gold Inc. (SA - Free Report) acquires and explores gold properties located in North America. Seabridge Gold has a Zacks Rank #2 and its expected earnings growth for the current year is 20.8%.
Marchex, Inc. (MCHX - Free Report) is a call analytics company. Marchex has a Zacks Rank #2 and its expected earnings growth for the current year is more than 100%.
DSP Group, Inc. (DSPG - Free Report) is a fabless semiconductor company, offering advanced chip-set solutions for a variety of applications. DSP Group has a Zacks Rank #2 and its expected earnings growth for the current year is 39.1%.
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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.