Breakouts: Key to materialize gains

When markets are in correction or in a Downtrend, 3 out of 4 stocks feel the pressure. Even fundamentally strong stocks with good financial strength and growth story fail to deliver results expected of them. These situations can be confusing and discouraging for investors. Even when the market seems to revive, one feels inhibited to actively take positions in individual stocks. Before the situation becomes clear, all the good stocks have already rallied and what’s left is a lost opportunity.

How does one cope and find a reliable and profitable way out of this randomness? Thanks to technical analysis and historical research, there are tools which can bring some method to this madness and be beneficial.

What is a breakout?

A breakout is the key to realize your reward that you earned from patience and extensive stock selection. Almost all rallies in stocks are preceded by strong and clear breakouts. When you have selected a stock with a convincing growth story but are confused about when to make an entry so as to make profits with minimum risk, that’s when you observe the price chart closely. When a credible breakout is observed, it’s the perfect time to put your money in the stock.

A breakout is a phenomenon that a stock exhibits after making a sound base pattern (any of the five bases) indicating that it’s ready for a rally. There’s a set pivot price which is dependent on the shape and form of the base pattern (like cup-with-handle, saucer-with-handle, flat base, etc.). When the stock crosses and ends above that pivot price, it’s said to have broken out and is set for further upside.

Example

Here’s an example of a successful breakout. HEG formed a  seven-week long stage two consolidation pattern, as visible on the weekly chart, between May 05, 2017 and June 16, 2017, with a pivot price of Rs 327. During the third week from pivot, the stock broke out of pivot price with a strong volume (290% higher than average volume) and showed further strength in the next two weeks with impressive price-volume action. The breakout was supported by a Confirmed Uptrend in the Nifty during the period. Subsequent to the breakout, the stock gave a massive 835% return in five months.

Signs of a good breakout

1.The base pattern of the chart from which the stock is breaking out from should be convincing with its shape, depth, and price-volume action along its formation.

2.Ideally, a good breakout is supported by strong volumes, and is typically 40% higher than 50-day average volumes. Strong volume indicates credible participation from institutional investors. Therefore, the stronger the volume is, the healthier the breakout will be.

3.Strong price action is favourable in a breakout. Gap up movements (stock opening significantly above previous day’s close and maintaining the gain) and stock ending near the day’s high are good signs to see accompanying breakouts.

4.A good breakout should have the support of a Confirmed Uptrend in overall market.  Breakouts in such markets have a higher chance of strong rally.

Related: Are breakouts that move more than 10% below from pivot in a single day prone to failure?

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