Top 5 Qualities Of The Best Stock Breakouts – Trading Strategy

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When buying breakouts of growth stocks, one of the three main techniques of our momentum swing trading system, there are certain technical criteria we look for because all the best stock breakouts share the same traits.

Last week (May 17), we sold a breakout swing trade in Pandora Media ($P) for a net gain of 14% with a holding period of less than three weeks. Prior to buy entry on May 1, the stock possessed the top 5 technical traits for breakout buying, which we have listed below (see the first chart below for a visual reference):

  1. High volume gap – On March 8, the stock gapped sharply higher to close the day with an 18% gain. Most importantly, volume spiked to approximately 700% its 50-day average level. When stocks score such a massive one-day gain that is accompanied by a monster surge in volume, it is undeniably the footprint of institutional buying (which we always want to see on the long side).
  2. 20-day MA > 50-day MA – During the formation of the base of consolidation that followed the March 8 gap, the 20-day exponential moving average remained above the 50-day moving average the entire team. This is a sign that the uptrend technically remains solid.
  3. Tight base above 50-day MA – As $P was forming its base, the 50-day moving average was rising up to meet the price. When that occurred, the stock touched and held key support of its 50-day MA several times. Simultaneously, the base began tightening up, which is typically a precursor to a breakout.
  4. First base after reversal off lows – This was the first real base that $P formed since its big reversal off the late 2012 lows (around $8). The first stage bases often have the highest odds of a successful breakout because the momentum of the new uptrend is just ramping up.
  5. IPO – Although not a requirement of breakout setups, one bonus is that $P recently launched as an IPO in 2011. If strong earnings growth and momentum exists, IPOs have a tendency to make explosive moves because of the lack of overhead supply (resistance).

Below is the daily chart of $P, as it looked at the time of our breakout buy entry:

$P breakout chart

After we determined that a valid base of consolidation had formed, we then focused on determining exactly when to buy. The technical factors that helped us drill down to a precision entry point were:

  • A “higher low” formed within the base (second touch of the 50-day MA)
  • Price broke out above the 6-week downtrend line started by the May 8 high
  • A tight range formed immediately upon breaking out above the downtrend line

The technical signals above told us it was the proper time to stalk $P for potential swing trade buy entry. In the May 1 issue of The Wagner Daily, we told subscribing members we would be buying $P if it traded above $14.18 (just above the April 30 high).

As anticipated, the stock triggered our buy entry that day, and we were long at an entry price of $14.20. The chart below shows our entry point, the subsequent price action, and our eventual exit point a few weeks later:

$P exit chart

As $P began climbing higher, our plan was to hold the swing trade as long as the price held above the steep uptrend line that formed on the hourly chart (similar to the way we recently trailed a stop to maximize gains on our swing trade of $SMH).

On the close of May 16, we raised the stop to just below that day’s low because we observed “stalling” action over the preceding two days and wanted to protect our profits. An analyst downgrade caused $P to gap down and hit our tightened stop on the open of May 17, but our sale at $16.17 still allowed us to lock in a nice 14% gain on the trade. This was just a bit less than the usual 20 to 25% gains we typically seek to achieve with breakout momentum trades.

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4 comments on “Top 5 Qualities Of The Best Stock Breakouts – Trading Strategy

  1. I see the breakout of the T/L on 4/24 but how did you then decide on your entry of $14.20? What triggered you believing the 5 days of consolidation after the T/L break would go higher and break the consolidation period? Also Bullet point 2 in the entry section should read March 8 high, not May 8 high as well. Thanks

    1. Hi Patrick,

      What we liked was the extreme tightening of the consolidation after the trendline was broken on 4/24. When there is such a tight volatility contraction, it usually precedes a resumption of the preceding and dominant trend (which is up in this case). So, we targeted $P for buy entry above the high of the 2 days prior to our 5/1 entry.

      Also, bullet point 2 is indeed correct, as March 8 refers to the consolidation that started with that day’s high (multi-month base building), not the micro consolidation of a few days before our 5/1 buy entry.

      Hope that answers your questions.

      Thanks for dropping us a line.


    1. Hi, sorry for the late response. We ALWAYS have well defined stops for every position we enter. Most stops are 4-8% away from the entry. I hope this helps. If you need more clarification please let me know. Thanks.

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