Selecting breakout stocks is probably one of the most favored techniques among active investors. The idea behind this kind of stock selection is to determine which stocks are trading within a narrow channel. These stocks are to be bought as soon as they move above this band and are sold when they fall below. In case a stock moves above this band, it usually gains momentum.
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.
Determining Whether It’s for Real
Stocks which have breached their resistance level should ideally be in high demand among traders. But the test of whether this is a genuine breakout is whether 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.)