Breakout stocks tend to witness explosive moves, making them some of the most exciting investments in markets. In this post, you’ll learn why these big moves occur, some common breakout patterns, and most importantly, how to identify breakout in stocks.
What Are Breakout Stocks?
Breakout stocks are shares that “break” through points of support or resistance levels on a chart. When they move through these barriers, it usually indicates that a new trend is underway.
As such, breakout stocks tend to be very popular with momentum and day traders, who look to “piggy back” off this momentum.
If a stock breaks through a resistance level, then it is likely to make a sustained move upwards. However, if it breaks through a support level, it will likely keep falling.
Why Do Traders Care About Stock Breakouts?
As mentioned, stock breakouts usually signal the beginning of a new trend. Therefore, active investors use breakouts to get into these trends early.
Needless to say that this can be extremely profitable.
Breakouts also coincide with heightened volatility, so they’re a great way to find the most volatile stocks.
Now, you may be asking yourself why this is. What makes breakouts so much more special than any other point on a chart?
Well, the theory relates to supply and demand.
Support and resistance levels occur at inflection points between the balance of buyers and sellers.
Resistance levels form when the balance tips in the favour of sellers, and support levels form when it tips in the favour of buyers.
Therefore, when these psychological barriers break, it means that one side has finally overcome the opposing force – signalling a structural shift in the balance of supply and demand.
Hence, the tendency for stocks to make big moves straight after.
How to Spot a Good Breakout Candidate
Now we understand the theory, how do we actually know if a stock is a breakout candidate? What should we look for?
The truth is, that breakout stocks come in all shapes and sizes. In other words, there isn’t a blanket definition that applies to all of them.
Stocks can breakout of channels, wedges, head & shoulders, inverse cup and handles, triangles, and many other “patterns”.
Essentially, when a stock trades near to established support and resistance levels, it classifies as a breakout candidate. A pattern recognition screener such as TrendSpider or Finviz Elite can help you identify these stocks.
I will cover some of the most common breakout patterns below.
Channel
“Channels” are one of the easiest patterns to spot. Whenever prices fluctuate between 2 straight, parallel lines, this is called a channel.
A horizontal channel is flat, an ascending channel slopes upwards, and a descending channel slopes downwards. Note, that “base” is another term for a horizontal channel.
Essentially, it doesn’t matter which direction the channel slopes. As long as prices are contained between an upper and lower bound, there’s the potential for a breakout.
The upper bound is the resistance line, which if broken is bullish. Conversely, the lower bound is the support line, which if broken is bearish.
Head and Shoulders
A head & shoulders pattern sounds complicated, but it is actually pretty simple. It looks exactly as it sounds. 1 large hump (the head) surrounded by 2 smaller humps (the shoulders) on either side. The “neckline” is a straight line that connects all 3 at their base.
When the head and shoulders are above the neckline, this is a bearish pattern. In this case, the neckline acts as the support level, which, if broken signals the beginning of a new downtrend.
Conversely, when the head and shoulders are below the neckline, this is a bullish pattern. This is also called an “inverse” head and shoulders, because it appears upside down. In this case, the neckline is the resistance level, which, if broken signals the beginning of a new uptrend.
Triangles
Triangles occur when stock prices converge to a singular point – almost like a pincer. In other words, prices consolidate over a narrower range before breaking through one of the converging trend lines.
Again, these come in different variations. You’ll come across symmetrical triangles, ascending triangles, and descending triangles. Some traders refer to these as “pennants” instead of triangles.
The upper line of the triangle is the resistance level, whereas the lower line is the support level. Either of these can be broken, however ascending triangles tend to be more bullish, whereas descending triangles tend to be more bearish.
Multiple “Retests”
The last thing to know about spotting good breakout candidates, is that the more times a support or resistance level has been tested, the more sustainable the breakout will be.
I would also add to this, that the longer a support or resistance level has been in place, the greater significance it has when broken.
For example, a stock breaking out of a 20-year base with 10 previous rejections of the resistance level, is much more interesting than a stock breaking out of a base on an intraday chart. However, that doesn’t stop breakouts being useful for both swing trading and day trading.
How to Identify Breakout Stocks
Ok, so now we know what a good breakout stock looks like, how can we identify them in real-time?
Surely we don’t have to manually flick through charts until we find one?
Thankfully, this isn’t necessary, because this is exactly what a stock screener is for.
If you don’t know how to use a stock screener, then this article will help you. Put simply, a stock screener automates the process of “flicking” through charts, helping you find the price action you want in a fraction of the time.
I’m going to show you the most effective breakout screens in my favourite stock screeners.
How to Find Breakout Stocks With a Stock Screener
If you haven’t heard of MetaStock, then you’re missing out. MetaStock is one of the best technical analysis platforms out there, with over 250 built-in screens.
Below is my go-to screen for finding breakout stocks in MetaStock:
New Highs Screen
A new highs screen is pretty self-explanatory. It finds stocks whose share prices are reaching new highs. This means that a previous resistance level has been broken in the process, alerting us to potential breakout stocks.
Now, you usually have to define a time frame for this “new high”. Is it a 10-day high, a 52-week high, or an all-time high, for example?
What’s great about this screen, however, is that it doesn’t constrain you to one specific time frame. As long as the stock has shown momentum leading up to it, you’ll get alerted to new highs across all sorts of time frames.
The screenshot below shows you how to run this screen on S&P 500 stocks:
Once the screen is complete, you will see the results in a separate window, as shown below.
If there aren’t too many stocks, I usually just open all their charts and quickly eyeball them. If slightly more stocks appear than usual, then I’ll just cherry-pick the names I’m more familiar with, or that I like from a fundamental perspective.
This highlights an important point about stock screening.
That is, just because screening alerts you to promising stocks, it doesn’t mean you blindly buy every one of them. You still need to conduct further research on them and apply discretion. Having said that, it certainly makes the process more efficient.
Now let’s analyse some of the stocks that caught my eye…
Amgen
The reason Amgen piqued my interest was because of its breakout from a bullish head & shoulders pattern.
Admittedly, the move looks extended so I probably wouldn’t chase it here. However, in the next section I will explain how to trade breakout stocks under these conditions.
WW Grainger
As you can see, WW Grainger is another stock reaching new highs, however I think the most interesting thing about this chart is the upward sloping channel it’s been in for 2 years.
While it hasn’t broken out of this channel yet (to the upside or downside), it is certainly worth watching for when it does.
This shows why you need to “eye-ball” the charts yourself, because you never know what other patterns you might discover. While screeners are good for speed and efficiency, they can’t quite match the human eye for pattern recognition in my view.
Gilead
Lastly, Gilead caught my eye because it was trading just below a long-term resistance line that it had failed to break though on at least 3 different occasions.
As mentioned earlier, if a support or resistance level has been in place for a long time and has been tested multiple times, it increases the significance of any eventual breakout from it. Therefore, this is definitely one to keep an eye on.
How to Scan For Breakout Stocks
Another stock screener that’s great for finding breakout stocks is Trade Ideas. Technically speaking, Trade Ideas is more of a stock scanner than a stock screener, whose difference you can read about in this penny stock scanner article.
Put simply, a scanner streams results in real-time, whereas a screener shows results at a point-in-time.
As such, Trade Ideas is better suited for intraday traders who want to be notified of breakouts as and when they occur throughout the day.
Breakout on Volume
Trade Ideas has a built-in scan called “Breaking out on Volume”. Unsurprisingly, this finds stocks hitting new highs across multiple time frames, with above-average volume.
Corteva (CTVA)
The image below shows what the alert window for this scan looks like. As you can see, results update in real-time so you never miss a breakout.
Corteva (CTVA) looked particularly interesting, because it was breaking out of an inverse head & shoulders pattern. Moreover, this had been forming for about 5 months, which added legitimacy to the breakout signal.
Principal Financial (PFG)
Principal Financial (PFG) was another stock that came up on this breakout scan multiple times throughout the day.
As you can see, the chart also resembled an ascending triangle, which as we established earlier is a bullish chart pattern.
Turns out this would have been a profitable breakout to trade, because the stock has gone on to make continued gains.
How to Trade Breakout Stocks
There are lots of different ways to trade breakouts. Some traders like to anticipate a breakout and get in before it happens, while others prefer to exercise patience and wait for the breakout to occur first.
Wait For the Breakout
Personally, I like to wait for the breakout to happen first. There have been too many times when I’ve convinced myself that a breakout is coming only to be disappointed when it doesn’t.
If you truly believe that a stock is about to make a big move, then you may as well wait for confirmation first. Getting in slightly earlier will only bring marginal benefits if you’re right, and just cause grief if you’re wrong.
Essentially, don’t be greedy and wait for confirmation!
Assess Volume
Another pre-condition worth bearing in mind is how much volume the stock is trading.
When a stock is breaking out on high volume, it usually means that institutional investors are behind the move. And, since institutions tend to hold positions for longer than retail traders, this supports the notion of a sustainable move.
Wait For a Retest of Support or Resistance level
When a breakout occurs, the role of the corresponding support or resistance level reverses.
Put another way, when a stock price moves through a resistance level, that resistance becomes support. Likewise, when the price breaks through a support level, that support then becomes resistance.
Therefore, a “retest” is when the initial breakout retraces back to the original support or resistance level, and confirms whether that level has in fact “reversed”.
If it does flip from support to resistance (or vice versa), then this confirms the legitimacy of the breakout. In other words, the breakout is likely sustainable.
Therefore, this temporary pullback provides a great entry point into a newly established trend.
Let me show you what I mean…
In the image below, you can see how Netflix came up on a “High Volume Movers” scan in Trade Ideas – alerting me to a pretty significant breakout. Moreover, this breakout was accompanied by a high relative volume of 15.64, which provided further impetus to the move.
Instead of chasing this breakout, it was best to wait for a retest of the old resistance line – which you can see is what happened in the chart below.
When the price bounced off of this line, it confirmed 2 things. Firstly, that this was a new support line, and secondly, that the breakout had legs. Therefore, this would have presented a good buying opportunity.
Remember Corteva (CTVA) from earlier? Well that’s another example of a successful retest following a breakout, confirming its old resistance is now new support. Again, this pullback offered a more attractive entry point than the initial breakout.
Know When The Signal Has Failed
Just as important as finding breakout stocks, is knowing when the signal has failed. These are otherwise known as “false breakouts”.
In the previous examples, a false breakout would have seen the stock price break through the support line instead of bounce off it.
For instance, in the chart of Yamaha below, you can see how it initially broke out of a bullish head & shoulders pattern. However, a few weeks later you can see how it price breaks through the support instead of bouncing off it. This is otherwise known as a failed inverse head and shoulders pattern.
When this happens, we know the breakout signal has failed. To minimize this risk, you should think about putting a stop loss just below the support line.
