3 Stocks Setting Up to Break Out

WINDERMERE, Fla. (Stockpickr) -- U.S. stocks are now trading at levels we haven't seen in over two years.

Since the Dow Jones Industrial Average broke out above some tough past resistance at 11,258, it has done nothing but trend higher and is now hitting fresh two-year highs. If this trend continues, the Dow will be challenging the psychologically important level of 12,000 in no time. The S&P 500 is also trading at levels not seen in two years. Ever since that index broke above 1,219, it has done nothing but trend higher toward its current level of around 1,284. It will be a major psychological advantage if the S&P 500 can manage to trade above 1,300.

Things are no different for the Nasdaq, which is also trading at fresh two-year highs. This tech-heavy index has also been on a tear ever since it broke out above 2,535. Traders should now watch for the Nasdaq to hit the very psychological important level of 3,000.

If all of these indices can manage to hit those key psychological levels, it will be a major win for the bulls. Ss the indices make their push toward those levels, stocks that are already trending with the market are likely to also head much higher. This is why traders should continue to monitor the markets for stocks that are breaking out, which can provide big profit opportunities if the market continues to show strength.

Related: Technical Setups for the Week

Trading breakouts is not a new game on Wall Street. This strategy has been pioneered by legendary traders such as William O'Neal, Stan Weinstein and Nicolas Darvas.

A breakout occurs when a stock makes a move through a significant level of support or resistance, which is usually followed by heavy volume and increased volatility. Wall Street players love to see an upside breakout because it demonstrates strength in the underlying asset as the price breaks above a level of previous resistance. An upside breakout can also take a stock to new highs, which will generate a lot of interest as the stock shows up on sophisticated software that scans for this type of action.

Here's a look at a number of solid breakout stock candidates that could have big upside potential from current levels.

Google

One market-leading tech stock that has now officially entered "breakout territory" is search king Google ( GOOG). This company maintains an index of Web sites and other online content and makes this information freely available through its search engine to anyone with an Internet connection. This stock is off to a decent start in 2011 with shares up around 6%.

If you take a look at the chart for Google, you'll see that the stock has started to push above some past overhead resistance at around $630 to $631 a share. This is a very significant move because Google had struggled since back in early 2010 to trade above $630. In fact, the last two times the stock has hit that level in the past year it has failed and sold off. What I really like about this move above $630 now is that it's coming prior to the company's earnings report which is due on Thursday.

This shows that stock is making a significant breakout right before key data is set to be released. What could be happening here is that institutional traders are worried about missing a big earnings move so they're buying the stock and paying up so they've exposure in case Google does release solid results. What's important now is that Google can manage to stay above $630 heading into the earnings report. If that happens, I think it will give the stock an excellent chance of trading much higher in the near future. Currently, the stock is trading right around $631, so watch how the stock closes today and tomorrow for conformation on a big earnings move to the upside.

Of course, any big up move will be dependent on what the company reports on Thursday If I had to judge based off of the volume the stock saw on Tuesday, I would say the odds are strong that this stock is going to trade much higher. The volume was 3.6 million shares on Tuesday as the stock traded up and broke out, vs. the three-month average trading volume of 2.4 million shares. Again, I think this demonstrates that large institutional money managers are getting into the stock ahead of the report.

Traders should now monitor how the volume finishes for today for even more confirmation that the stock wants to go higher. If Google ends the day down and you're a bull on the stock, look for the selloff to occur on lighter volume then what we saw on Tuesday. Then look for another strong volume up day on Thursday as we head into the earnings report set for after the market close. If the bullish trend for Google can continue, I think this stock will make its way towards $700 a share very soon.

Major Google bulls include George Soros, who increased his position in the stock by 1541.6% in the most-recent period, and Tiger Management's Julian Robertson, whose portfolio is 6.7% weighted toward the stock. Google was included on a recent list of stocks with large insider selling after insiders dumped $68.5 million worth of stock. TheStreet Ratings has a B buy rating on Google, earning it a spot on the Top-Rated Internet Software Services Stocks list.

Medicines

Another stock that has started to breakout is Medicines ( MDCO), a global pharmaceutical company focused on advancing the treatment of critical care patients through the delivery of medicines to the worldwide hospital marketplace. This stock is off to a blazing start in 2011 with shares already up 13%.

If you take a look at the chart for Medicines, you'll that the stock has started to breakout above some past overhead resistance at around $15 to $15.30 a share. This breakout is significant because Medicines has struggled to get above those levels for the past five months. Every time the stock traded up towards $15 or $15.30 it usually sold off pretty sharply. Now the stock has cleared those levels and has even started to move above $16 a share.

What's great about this breakout in Medicines is that the move has pushed the stock toward a new 52-week high, which it hit on Tuesday at $16.42 a share. Even with the stock off slightly today at around $16, it's still trading very close to that 52-week high. Whenever a stock hits a new 52-week high , it starts to get more attention among the trading community as market players scan the market for stocks that are showing relative strength.

It's also worth noting that the volume during the past couple of trading sessions has been reasonably strong as the stock started to breakout. The last two trading sessions (both up days) has seen volume clock in at 400,000 shares and 445,000 shares, which is well above the three-month average trading action of 367,000 shares. If the uptrend continues for MDCO, traders should look for this stock to move back towards the next resistance levels in the mid-$20s. That's pretty decent upside from here for a stock that looks to be gathering some strong momentum.

Medicines is rated a C hold by TheStreet Ratings.

MercadoLibre

One final stock that has started to breakout is MercadoLibre ( MELI), which, through its subsidiaries, hosts online commerce and payments platforms in Latin America. Its services are designed to provide its users with mechanisms to buy, sell, pay for, and collect on e-commerce transactions. Some traders like to call this stock the eBay ( EBAY) of Latin America. So far in 2011, the stock is off to a strong start with shares up around 9.4%.

If you take a look at this chart, you'll see that the stock formed a major breakout on Tuesday after shares pushed above some past overhead resistance at around $77 a share. At one point on Tuesday, the stock traded over $79 a share, but it wasn't able to close as strong it traded intraday and the stock finished around $75. Now some traders might look at this as a failed breakout, but I would stress that the volume on Tuesday was extremely strong with over 1.4 million shares changing hands versus the three-month average trading volume of 854,000 shares.

That strong volume tells me that some real buying interest from large institutional money managers came into the stock. And despite the weaker close, and the stocks slight selloff today down to $73, this name could be gearing up for a big run higher in the near future. Sometimes stocks breakout and then selloff and trigger lots of stops before they rest and then gear up again to move higher. I think that's what could be at play here with MELI.

Traders should now watch to see if the stock can hold some prior support levels at around $72 to $70 a share, if it even trades that low. As long as the stock doesn't trade below those levels, then I think it will trade sideways for a bit and make another run at breaking out over $77 to $79 a share. Keep in mind that over 12.5% of the float is currently sold short on MELI, so those shorts are going to do everything they can to keep this stock from breaking out.

If the bears fail to hold it down though, watch for a major short squeeze to develop that could have the potential to take this stock to $100 a share. I would also point out that the all-time high on this stock is right around $80 a share, which in my opinion is why the stock didn't hold that first breakout attempt. A second attempt at breaking out, if it does indeed happen, could easily be more successful and mean this stock wants to head significantly higher.

MercardoLibre shows up as a top holding of Chase Coleman's Tiger Global Management, 6.9% of the total portfolio. With a B buy rating, it's one of TheStreet Ratings' top-rated Internet software services stocks.

To see more breakout action in stocks such as North American Palladium ( PAL), Travelzoo ( TZOO) and Broadcom ( BRCM), check out the Breakout Stocks of the Week portfolio on Stockpickr.

-- Written by Roberto Pedone in Winderemere, Fla.

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At the time of publication, author had no positions in stocks mentioned.

Roberto Pedone, based out of Windermere, Fla., is an independent trader who focuses on stocks, options, futures, commodities and currencies. He is also an outside contributor to Beconequity.com and maintains the website Maddmoney.net, which he sold to Blue Wave Advisors in 2008. Roberto studied International Business at The Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany.

Roberto Pedone, based out of Windermere, Fla., is an independent trader who focuses on stocks, options, futures, commodities and currencies. He is also an outside contributor to Beconequity.com and maintains the website Maddmoney.net, which he sold to Blue Wave Advisors in 2008. Roberto studied International Business at The Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany.

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