Stocks
form certain time-tested chart patterns, just before "breaking
out" to new highs. At Stock Confidential, we are constantly
on the lookout for market-leading stocks that are forming
cup-with-handle, double bottom, flat base and other explosive
chart patterns, so that our subscribers can profit from
a stock’s potentially dramatic price increase.
The three
most important things we look for in potential breakout
stocks are: 1) A stock with
solid fundamentals, 2) A potentially explosive stock chart
pattern, and 3) Well above-average breakout volume.
Most of the companies we feature rank in the 80’s or 90’s in EPS
(earnings per share) and RS (relative price strength) as ranked by Investors
Business Daily. These are generally considered
the market’s best-performing stocks. But we look at other
criteria too. Hi-Tech Pharmacal (symbol: HITK), for example, had a 98 EPS rating
and a 99 RS rating when we featured it in Stock Confidential. It also showed
an "A" accumulation ranking, meaning there was an abundance of buyers
of the stock, and its industry group also was rated an "A."
Since we monitor hundreds
of quality stocks like Hi-Tech Pharmacal, HITK
was already on our radar screen when we saw it
form a potentially explosive "cup-with-handle" above
its initial breakout from a "double bottom" chart
pattern. From this chart, and the
stock’s decreasing volume, it seemed clear
that the stock was setting up to break through
a price resistance area around $20.07.
On the
day of its breakout, HITK shot up to $21.47, $1.40 above
our $20.07 pivot/buy price. By day two, it was up to $22.56,
or $2.49 above its pivot. Less
than a week after its breakout, HITK closed at $27.45, $7.38
above its pivot!
But what would you have
noticed about HITK on the day of its breakout other
than the fact that the stock was approaching our
$20.07 pivot/buy price? The answer lies in the stock’s
volume. This is what we sent to our
subscribers:
Potential
Breakout Stocks
| Symbol |
Company |
$Pivot |
$Cur.
Price |
Avg.
Daily Vol. |
| HITK |
Hi-Tech
Pharmacal |
20.07 |
18.45 |
118K |
This
told our subscribers to be expecting HITK to hit the $20.07
buy point, or "pivot," on well above the 118,000-share-per-day
level the stock was averaging. Let’s add a volume
chart below the price action of HITK, so we can visualize
the stock’s breakout volume.
Prior
to its breakout, with few exceptions, HITK’s volume
stayed pretty close to the black line going across the
bottom of the volume chart. This line is the stock’s
volume, or number of daily shares traded, in the form of
a 50-day moving average. (The moving average just averages
the volume over the last 50 days and puts the information
in the form of a line).
On
its breakout day, HITK racked up an impressive 628,900
shares (see first "up" arrow), or five
times its average daily volume! So
from the beginning of that market day, you would
have noticed HITK approaching its pivot, or "buy
point," on volume that was clearly pacing well
ahead of its daily average. A few days later the
stock showed extreme strength as its volume spiked
above its initial breakout volume.
One
way to gauge a stock’s breakout volume is to
make sure it is pacing well above 10% of its daily
average volume for each half hour of the trading
day. The more above this 10%, the
better. In other words, you would have wanted to
see HITK’s volume be at least 11,800-plus shares
in the first half hour of trading. 23,600-plus shares
by the second half hour, etc. Obviously, HITK’s
volume was well above these modest levels.
Here
is HITK’s chart several days later. Had you bought
HITK at or near its pivot, you would have bought it just
as it started to head up in a big way.
Breakouts
are a great way to enter quality stocks, because
they can help determine when a market-leading stock
is most likely to see an explosive price increase. They
often act as a final proving ground for quality stocks
before they take off.
Like
all stocks, breakout stocks tend to follow the strength
of the overall market. In weak or uncertain markets, fewer
stocks break out, and sometimes those that do can breakout
above their pivots only to retreat back to them or below
them until conditions improve. In strong markets, breakouts
can be very powerful, accompanied by a dramatic increase
in the stock’s value.
Leading
stocks suffer from bouts of selling just like other stocks.
This selling pressure can be created by market downturns,
analyst downgrades, negative news about the stock, or a
sector temporarily falling out of favor, etc. At Stock
Confidential, we examine these downturns for signs that
the stock is ready to head back up again.
We look
for several things in our featured reversal stocks. These
include 1) A stock with solid
fundamentals or leadership potential, 2) A stock that is
reaching an area of price support, such as its 20, 50,
or 200-day moving average, 3) Recent climactic volume,
and 4) A stock that is forming one or more candle
reversal patterns.
Most of the reversal stocks we feature rank in the 80’s or 90’s in
EPS (earnings per share) and RS (relative price strength) as ranked by Investors
Business Daily. These are generally considered
the market’s best-performing stocks. But we also occasionally
consider past winners that are trying to regain their dominance.
Varian
Medical Systems (symbol: VAR) sported a 94 EPS (earnings
per share) rating and a 92 RS (relative price strength)
reading when we saw its shares plummet for some unknown
reason. Moreover, the stock was in one of the market’s
strongest industry groups with an "A" rating
in this category, and it had a solid "B" accumulation
rating, so there was no lack of potential buyers for the
stock.
VAR slashed below its 50-day moving average (the bright green line), an area
of support for the stock in the past. Large institutional investors (mutual
funds, investment houses, etc.) typically buy quality stocks at or near their
50-day moving averages.
In addition to hitting
a traditional support area, the stock experienced
huge, climactic volume (see the "up" arrow
in the volume portion of the above chart). Seeing
this in the absence of any news or other factual
reason for the stock’s decline, we featured
VAR at a buy point slightly above its close at $49.15.
Since
reversal stocks are riskier to trade than breakout stocks,
and can take longer to turn around and head back up again
than expected, VAR dropped another $1.55 the day after
we featured it. But the day
after that, the stock gapped up $4.84, tacked on another
.92 the day after that and another .78 after that. Had
you sold the stock four days after we featured it, you
would have pocketed a $4.89 gain!
Sometimes, a stock will flash one or more candle reversal
patterns in addition to the other technical criteria discussed above, just
before it potentially turns and heads back up again. Here’s Avocent (Symbol:
AVCT), descending below its 50-day moving average support area (bright green
line). There is no climactic volume, but the stock has formed an inverted hammer/doji
after several big down days.
 
Having
exhausted its downward momentum, Avocent was now free to
head back up above its 50-day moving average in a big way.
From its $21.89 close on the day it formed the inverted
hammer/doji, to its close just seven days later, it notched
a $5.52 price move. For more on candle
reversal patterns click on this link.
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