When markets are in a correction or in a Downtrend, 3 out of 4 stocks feel the pressure. Even quality stocks start falling. These situations can be discouraging for investors. So, 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 would 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, 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.
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 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.
3. 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.
4. A good breakout should not be when market is in correction or under pressure. Breakouts in such markets have a higher chance of failure.
Example
Here’s an example of a successful breakout. Bata India formed a 12-week-long cup-with-handle pattern, as visible on the chart. The accumulation was good in the right side of the base and volumes dried up during handle formation. The stock broke out of pivot price with a strong volume and advanced more than 35% in the next four months.
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