Buying Breakouts - Part 2

I have been trying to temper my longer term bearish outlook with some lessons and trade ideas on quality growth stocks in recent weeks. Even if the market does make new bear market lows in the future, the current rally has been large enough and lengthy enough to be classified as a bull market in its own right. There has been plenty of time for stocks to undergo basing periods since March, and add to that the huge number stocks that did not confirm the new lows in the indexes in February and March. So quite a number of quality issues have been basing since Nov 08.

From looking at tons of charts in recent weeks, and particularly the last 2-3 weeks, it appears that many stocks are forming or have broken out of 2nd stage bases recently. For those who are not familiar with the concept of "bases" or the staging, I am referring to it as in IBD literature. A base is a period of organized consolidation in a stock price at which point many shares are aquired in a fairly narrow price range by institutional traders. These bases typically have a rounded or flat bottom rather than a V shape. There are a few classic basing patterns that show up again and again before major moves in stocks. The importance of recognizing these bases is that big moves in stocks typically occur in short periods of time right after they breakout of a base. So if you don't recognize the base before the breakout, then you often are late to the party on buying.

IBD literature suggests that stocks can often form 2 to 3 quality bases in a bull move, before undergoing large corrections. After 3 bases many basing patterns will be faulty and failure prone. So right now, many stocks may still be in quality basing periods. Having a chart defined stop or a sound % loss limit will help to assure not sticking around in failed bases or subsequent major market turns to the downside.

Now the chart above is LFT which is a top 20 IBD stock right now. This chart was made Friday and does not reflect today's action. The notes on the chart show key points and how I would trade it. I am not in this but may trade it soon. Price moved above the buy point on that chart today, and volume is running high, but it looks more like the handle is continuing to form rather than a real breakout. So it may be more sensible to move the buy point to a few cents above today's high, to help avoid a failed breakout. Earnings is Aug 18 I believe FYI.

This is a chart of JST, another IBD 100 stock. Last week I bought this after it had broken out on heavy volume. I used a limit order of the breakout price (33.00)to catch it on a retest back to that price level. So these two charts show how I would buy growth stocks breaking out of bases. If you see the base before the breakout, you use a buy stop order to buy on a move up above the breakout price (handle, midpoint, old high, etc). If you don't see it before the breakout, or you are unsure about the base, then you can wait till the breakout, and use a buy limit order corresponding to the breakout price to get it IF it comes back down to the breakout price.

The problem with the second way is that you may not get filled because price doesn't come back down that far. However, it may save you from some failed breakouts. Look at the notes for when to get out. In general, you simplify the exit by selling with a market or limit order when the price is up 3 times the amount of your risk (in percent terms). The key to keeping a good risk reward ratio is to exit the stock on any close back below the breakout point - that will get you out several percent better than getting stopped out most of the time, possibly cutting the size of your average loser in half if compared to always getting stopped out.

Another notable stock that is breaking out today is TNDM. I had considered highlighting this recently, but the base is choppy looking, so I didn't really want to use it as an example. However, now that heavy volume is coming in on a breakout, you could use the buy limit method to buy it on a pullback to the breakout point of 31.50. Then follow all the rules about getting out if price closes below that level.

I don't really intend on posting trades on individual stocks like this on the blog (at least not until I believe that we are in a legit long term bull), but I know some of you reading this are familiar with and interested in this methodology, so please do your own homework on any stocks I bring to the table, and feel free to post comments or questions.