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What is a breakout in stocks?

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.

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 that can bring some method to this madness and be beneficial.

First, let’s answer your question-

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 that 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.

A breakout is 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.

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 with 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 the 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 the overall market. Breakouts in such markets have a higher chance of a strong rally.

Here’s an example of a successful breakout. Coromandel International formed a cup-with-handle base, as visible on the daily chart. The stock broke out of its pivot price on strong volume and progressed well. Subsequent to the breakout, the stock gave more than 20% return in seven weeks.

To gain more insights into the stock market and learn share market basics, visit www.marketsmithindia.com.

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Sunday, 05 July 2020

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