Trading breakout stocks is one of the most popular methods used by stock traders. It is excellent and easy to understand for new traders – you identify a precise level and capitalise on a break of that area.
If the price falls below that level, it may be a good time to offload or short the stock, but it could provide an excellent opportunity to go long and benefit from some upward momentum if it breaks above. Here we will take you through breakout trading and identify four of the best breakout stocks to watch.
What Is Breakout Trading?
Breakout trading is trading a stock that trades outside of a defined support/resistance or range.
The support range is the level at which the stock price does not fall any further, and the resistance level is the level at which the stock price does not rise any further. Usually, stocks move between these two levels. If they go beyond the support or resistance line, it becomes the new support or resistance level. If a stock breaks a defined level, it usually indicates that the price will continue in the direction of the break.
Breakouts that occur on high volume provide more significant momentum and indicate that price is more likely to trend in that direction. When the price breaks through the resistance and support level, the traders who were waiting immediately jump in and those who did not want the price to break out exit the position to cut down on their potential losses.
One thing to be aware of is that not all traders will use the same support and resistance levels, and so a breakout on low momentum can indicate that the move has less chance of success.
Some breakout levels can be identified by looking at the trading range of the current price, along with previous price action; whereas other breakouts could be psychological levels. If you take the example of a stock trading at new highs, round numbers such as $100, or $1000 can prove to be psychologically important levels.
It may be that many have set stops, or take profits at these rounded levels, but it can also be that markets are also waiting to see how a stock responds to these new prices.
How To Find and Confirm Breakouts
The Basics
- Plot out resistance and support levels
- Look for consolidation patterns to identify ranges for breaks
- Check volume against average. Spotting volume building, and significant increases on breaks can give an edge
- Keep an eye on fundamentals, catalysts, and sector trends
- Be sure to check and confirm breakouts or breakdowns across multiple time-frames, and watch for retests
There are various ways to find breakout stocks, but most will start with technical analysis, or taking a look at the charts. If you are looking to narrow down the options to check, looking at stocks making the biggest moves is a decent place to start. Checking our shares page can give you an overview of some of the biggest daily movers for you to conduct some of the following analysis.
The two main technical indicators you will want to use when looking for breakouts are the RSI, and the MA. The RSI (relative strength index) is a momentum oscillator can help you determine if a stock is overbought or oversold. A breakout accompanied by an RSI moving from oversold to neutral territory is a bullish sign, but one moving into overbought may be one that is destined to pullback and retest for a breather.
The moving average lines will give you some moving targets, with a break above or below key levels (50 period, 200 period) potentially signifying a trend change. A moving average break along with a key level breaking in a stock could be a strong breakout signal.
Plot Out Some Key Support & Resistance Levels
Start by using historical price data to pinpoint where the stock has repeatedly faced resistance, or found support. Support and resistance levels are price points where a stock has historically struggled to move above, or below, and are marked out or watched by almost all market participants.
A breakout above or below either level, especially with high volume, is a strong signal. It can take stocks multiple attempts to break through these levels, but when a successful breach happens, it can signal a breakout.
Often after a breakout, markets might look for the stock to pull back to retest the previous resistance level (now support) or support (now acting as resistance). If the stock manages to hold the breakout level on the retest, it ‘confirms’ the move and provides a firmer entry signal.
It is usually a good move to look at the stock across different time frames (hourly, 4 hour, daily) to confirm the breakout as if the break appears on on multiple time frames it can have a greater chance of holding.
Look For Consolidation Patterns or Range Trading
See if the stock has previously been trading within a range for an extended period. Common consolidation patterns include triangles (ascending, descending, symmetrical), rectangles, or flags. These patterns often precede a breakout.
A period of consolidation often represents a balance between buyers and sellers. When the stock breaks out of this range, it can indicate that one side has gained control, leading to a strong move in that direction.
Is Volume Significantly Higher Than Usual?
A significant increase in trading volume during a breakout is a key indicator of the breakout’s strength. Check the daily volume on the chart, along with the average daily volume (ADV) of the stock. High volume suggests that more and more traders or investors are entering the market, accepting (or providing support) to the new price level.
Stocks that breakout with low volume might find it more difficult to sustain the run, leading to a false breakout. You would want to find stocks that are showing at least 50% higher than average volume as a confirmation signal.
Fundamentals & Sector Trends
Positive catalysts can provide increased volume, and help push a stock into breakout territory. A catalyst can take many forms; from product launches, partnerships, or industry developments, through to earnings releases or analyst price target revisions.
Stocks will also often move in tandem with their sector. A strong-performing sector can lift individual stocks, leading to more extreme breakouts. Broader market conditions being bullish would generally support breakouts, while bearish markets may support breakdowns in price. As one point of risk management, you should also pay attention between some of the differences between breakout stocks, and those that are in the midst of a short squeeze as these can move in similar ways, but break down very differently.
