As favored a strategy as it is divisive, picking breakout stocks is one of the most popular techniques among active investors. The idea is fairly simple -- to identify stocks trading within a narrow band and buying 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 of the risk of timing such a move or identifying a wrong breakout level. However, when executed correctly, this strategy can yield lucrative gains, which explains its enduring popularity.
Identifying Breakout Levels
The key to this strategy is calculating the support and resistance levels of a stock. The floor 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 resistance 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.
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 7106 stocks to only nine.
Here are five of the 12 stocks that passed the screen:
Monotype Imaging Holdings Inc. provides customers worldwide with typeface solutions for a broad range of creative applications and consumer devices. Monotype Imaging Holdings has a Zacks Rank #1 (Strong Buy) and its expected earnings growth for the current year is 15%.
MAG Silver Corp. (MAG - Free Report) focuses on the acquisition, exploration and development of high-grade mineral properties in Mexico. MAG Silver’s expected earnings growth for the current year is 8.2%. MAG Silver has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Barrick Gold Corporation (GOLD - Free Report) is the largest gold mining company in the world. Barrick Gold has a Zacks Rank #2 (Buy) and its expected earnings growth for the current year is 32.7%.
Loop Industries, Inc. (LOOP - Free Report) is a technology company. It created a revolutionary process which decouples plastic from fossil fuels, breaking down waste PET plastic to its base building blocks. Loop Industries has a Zacks Rank #2 and its expected earnings growth for the current year is 2.6%.
Nomura Research Institute, Ltd. (NRILY - Free Report) provides research, business consulting and systems services. Nomura Research has a Zacks Rank #2 and its expected earnings growth for the current year is 12.3%.
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.