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 are 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.)
• 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 $25 (Stocks which are reasonably priced.)
These criteria narrow down the universe of over 6878 stocks to only 4.
Fly Leasing Limited (FLY - Free Report) is engaged in acquiring and leasing commercial jet aircraft under long-term contracts to a diverse group of airlines throughout the world. Fly Leasing has a Zacks Rank #1 (Strong Buy) and its average EPS surprise for the last four quarters is 41.3%.
L.B. Foster Company (FSTR - Free Report) is engaged in the manufacture, fabrication and distribution of rail and trackwork, piling, highway products and tubular products. L.B. Foster’s average EPS surprise for the last four quarters is more than 100%. L.B. Foster has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
CECO Environmental Corp. (CECE - Free Report) is a provider of fluid handling and industrial air quality systems. CECO Environmental has a Zacks Rank #2 (Buy) and its average EPS surprise for the last four quarters is 25%.
Enphase Energy, Inc. (ENPH - Free Report) delivers microinverter technology for the solar industry, which increases productivity and reliability of solar modules. Enphase Energy has a Zacks Rank #2 and its average EPS surprise for the last four quarters is 31.7%.
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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.