Charts of the Day: Breakout Stocks

By Roberto Pedone

Stocks that enter the successful phase of a major breakout can produce some massive profits for those investors lucky enough to be long the name ahead of the move.

A breakout is a significant technical indicator because it demonstrates that a stock is strong enough to trade through a level that represented previous resistance where the stock ran into selling pressure. Previous resistance is often an area where the sellers have taken control of the stock from the bulls. Once the sellers take back control of a stock, they will quickly apply pressure to push share prices lower and prove that the stock wasn't strong enough to move higher.

That is exactly why a breakout on any stock is so significant. Once a stock builds up enough buying pressure to take out the previous sellers, it usually means the stock has only one place to go, and that's higher. Sometimes stocks will actually make a breakout and then sell off. This is normally considered a false breakout, so keep in mind that a breakout must be confirmed by the ability of the stock to continue to trend higher and stay above previous resistance levels.

Strong volume is often a great indicator of a real breakout. If a stock can trade above previous resistance and be accompanied by strong volume, it shows that that move has a much better chance of being successful.

Take a look at the chart of Palm(PALM Quote). The stock broke out back in February, but the move wasn't accompanied by strong volume. Subsequently, the breakout failed, and the stock traded down from $9.50 a share to $5.85. After that selloff, the stock made another attempt at breaking out and was finally successful as the selling volume dried up. Shares are now trading at about $15.30, so you can see that once a stock breaks out, the potential for large gains is great.