News Analysis date published New: 
Tuesday, December 4, 2012 - 14:30
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Tuesday, December 4, 2012 - 18:32
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Tuesday, December 4, 2012 - 14:30

5 Steps to Profiting from a Breakout Stock

Tuesday, December 4, 2012 - 2:30pm

There are many strategies investors use to profit in the stock market. One of the most effective and time-tested methods is the technical breakout strategy.

According to the breakout strategy, the investor should wait for the stock price to break above (or below in the case of shorting) a certain price level before entering the trade. The theory behind this tactic is that the price momentum resulting from the original move will continue, creating profit opportunities for that stock.

The opening range breakout, or ORB, became popular with Toby Crabel's book "Day Trading With Short Term Price Patterns and Opening Range Break Outs." But don't let the term "day trading" confuse you. Like I said before, these strategies can be used in any time frame. Since he wrote this book in 1990, he has become a billion-dollar hedge fund manager using these tactics.

Breakout strategies can be successfully used for any time frame. Whether you trade on an intraday level or simply want a long-term investment, the breakout strategy is always a good starting point.

So here are the five simple steps for longer-term investors to trade daily breakouts.

Step 1. Mark a recent high on a stock's daily chart. It doesn't necessarily need to be the daily high -- the breakout line can be drawn at the simple moving average or other technical resistance pattern. The daily high is just one way to use the breakout strategy. Let's use the chart for Google (Nasdaq: GOOG) as an example.

Step 2. Draw a horizontal line at this high. If you are not sure which direction a stock is going to breakout, or are willing to short, then you can use a channel rather than a single line. To create a channel, draw two lines on the chart, with one at the low and the other at a high of your chosen time frame. You can also draw this two-line channel on technical patterns rather than the highs or lows. If the price breaks above the upper channel line, go long. If the price breaks below the lower line, short.

Step 3. Patiently wait for a daily bar to close above this line -- this is the breakout.

Step 4. Buy the stock with the line now indicating the initial stop level.

Step 5. As price moves up, move the stop level based on your risk tolerance and goals in order to lock in profits. However, it sometimes takes several entries at the breakout point before the momentum is enough to carry your trade into profits.

Here are three stocks about to breakout on the upside:

1. FMC Technologies (NYSE: FTI)
FMC provides technology solutions to the energy industry. It boasts a $9.6 billion market cap and earnings are expected to grow almost 27% next year to $2.36 per share. Despite this good prospect, the company is mired in more than $1.5 billion of debt and only $600 million in cash.

The recent high of $42 is my daily breakout point. If the price closes above $42 on a daily close, then enter long with a target at the 200-day moving average of $45.

2. Calpine Corp. (NYSE: CPN)
Calpine is an independent wholesale power-generation company that owns and operates natural gas and geothermal power plants in North America. With a market cap of just above $8 billion, the company is projected to report earnings of $1.45 per share in 2013, a 25% increase year over year. It boasts a nearly 45% profit margin, but its debt-to-equity ratio is quite high at about 2.5.

This stock is very close to triggering a breakout entry opportunity. The daily breakout level is the 200-day simple moving average at $17.20. A daily close above this level is my breakout entry level. The recent high of $18.80 makes a good technical target.

3. Janus Capital Group (NYSE: JNS)
Janus is an asset-management company with close to $2 billion in assets and a market cap of roughly $1.5 billion. Year-over-year revenue increased 1.5% in the third quarter to $209 million, while earnings estimates were met at 15 cents per share. Full-year earnings are expected to reach 56 cents and increase 9% in 2013 to 61 cents a share.

The 50-day moving average creates a breakout level in this stock with a target price of $9.50, based on the technical picture.

Risks to Consider: Breakouts are not guaranteed profits. In fact, stocks that are breaking out often fail to continue in the direction of the breakout. This is why it's critical to use the entry level as the initial stop loss. Combining volume and fundamental factors along with the technical breakouts may increase the odds of their success.

Action to Take --> I like all three of these stocks as breakout "buy" candidates due to the technical price action. Remember, always use stops and position size properly based on your capital base, goals and risk tolerance.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.