Last week, we discussed about CANSLIM parameters such as EPS, Price Strength, and Group Rank to increase your chances of winning. But it is important to initiate your positions at the proper time. A breakout from a base pattern is considered an ideal time to buy a stock.
When markets are correcting, three out of four stocks feel the pressure. Even fundamentally strong stocks with good financial strength and growth story fail to deliver results expected of them. So, even when the market seems to be reviving, one feels inhibited to actively take positions in individual stocks. Before the situation becomes clear, all 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 through 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. BATA formed a twelve-week-long cup-with-handle pattern, as visible on the weekly chart. The stock broke out of from its pivot price with a strong volume and progressed well. Subsequent to the breakout, the stock gave more than 35% return in five months.
Signs of a good breakout
- 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.
- Ideally, a good breakout is supported by strong volume, and is typically 40% higher than 50-day average volume. Strong volume indicates credible participation from institutional investors. Therefore, the stronger the volume is, the healthier the breakout will be.
- Strong price action is favorable 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.
- A good breakout should have the support of a Confirmed Uptrend status in overall market. Breakouts in such markets have a higher chance of strong rally.
What do you think? Please email us any questions or comments.
Disclaimer: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. It is for educational purposes only.
Performance computations reflect a time-weighted rate of return and includes a brokerage of 0.5%. All holdings are rebalanced to equal rupee amounts daily. Dividends are not considered in computations. Percent gains and losses are calculated for all issues that remain on the “Current Holdings” at the end of the day. For stocks that were added to “Current Holdings”, the basis used to calculate the percent change is the price noted when the issue appeared as a “Current Holdings” in MarketSmith India. For stocks that were removed, the selling price used to calculate the percent is the price note d when the issue appeared as “Removed” in the MarketSmith India. For more information, see our Legal disclosures here.