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3 Stocks Setting Up for a Breakout - 55936 views
Are stocks in the U.S. about to put in a short-term top -- or even worse a longer-term top that could lead to much lower stock prices?
That could very well be the case. The S&P 500, which is the most followed and tracked average, seems to have rejected a breakout that had many market bulls excited about the future prospects for stock prices. The S&P 500 managed to finally trade above the former yearly highs at around 1220 just a week ago, but that breakout didn’t last long. In fact, the S&P was only capable of climbing around 7 points above the breakout before this major average put in a key reversal day and sold off.
Last Tuesday, the market saw a key reversal day, which is a sharp reversal pattern that happens during a trending market. Basically, a reversal pattern occurs when a market opens up above the previous day’s closing high and then reverses and closes below the previous day’s closing low. That is exactly what happened last Tuesday, and this type of technical pattern can often times lead to big corrections in the market.
As someone who follows the technical action of the market very closely, I can’t say I am thrilled to see this key reversal happen right after the S&P 500 was starting to break out. It could mean that the breakout was a false move and market players are distributing stock. But before we can be sure this is the case, we must watch this week to see if the market can recover and consolidate and move back into its uptrend.
Regardless of what the market decides to do, there are always going to be stocks that are breaking out and preparing to trade significantly higher.
As Jim Cramer likes to say, “There’s always a bull market somewhere.” And bull markets often start with stocks that are breaking out and demonstrating relative strength. Remember, a bull market in a sector or any stock for that matter can develop even if the rest of the market might be demonstrating weak price action. This is why it’s so important to monitor stocks that are breaking out.
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.
The first stock that is starting to enter pure breakout territory is Tesla Motors (TSLA), which designs, develops, manufactures and sells fully electric vehicles and electric vehicle powertrain components. The company is most famous for its commercially produced electric car, the Tesla Roadster. Year-to-date, Tesla has been a wonderful performer, with shares up a whopping 32%.
If you take a look at the chart for Tesla, you’ll see that the stock is starting to show that a major breakout above some previous overhead resistance at around $30.42 a share could be under way. This breakout, if it holds, is big because now the stock is trading near all-time highs (hit today at $32.94) after launching its IPO back in late June. I love stocks that are trading at all-time highs because it means the shares have less and less overhead resistance to clear to head much higher.
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It also means that just about anyone who has ever bought the stock is making money, and that is the kind of company you want to be in when owning any stock. Relative strength like we’re seeing in Tesla acts like a magnet and attracts new buyers who don’t want to miss out on the run. It’s a very powerful technical force that market players shouldn't ignor. Tesla Motors started to show this strength last week when the stock refused to go down even as the overall market pulled back.
This is one of the reasons I love down days because it makes it very easy to isolate the strong stocks that are trading up while everything else is getting whacked. For example, another stock that was trading up on Friday when the market sold off sharply was Research In Motion (RIMM). It might be worth keeping an eye on RIMM here for higher prices as well or Tesla Motors.
One of the fundamental reasons that is helping to push Tesla higher is the recent news that the company plans to make a big push into Japan. Tesla CEO Elon Musk said on Friday that he expects Japan to become the company’s largest market outside of the U.S. in terms of sales over time. The company recently opened its first showroom in Asia last month, which builds in its additional six other dealerships in Europe.
In the short term, the stock is trading in overbought territory with the relative strength index (RSI), a technical momentum indicator, showing a reading above 80. If you’re looking to buy this stock, let it cool off and start consolidating some of the recent gains before jumping in. If you’re short this stock, I would seriously start questioning why since the stock is showing not a single reason to bet against.
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Another stock that’s close to a big breakout is Kodiak Oil & Gas (KOG), which is an independent energy company focused on the exploration, exploitation, acquisition and production of natural gas and crude oil in the U.S. This stock has been a huge winner year-to-date, with shares up 95%, and that upside run looks far from over.
If you take a look at the chart, you’ll see that shares of Kodiak Oil & Gas recently broke out above $4.34 and traded up toward $4.55 a share before cooling off and pulling back. Now the stock is mounting another run at getting back above $4.55 and continuing on its breakout mission. If the stock succeeds at clearing $4.55 then the next overhead resistance levels to watch will be at $5.50 to $6 a share.
It’s worth noting that volume in the past number of weeks has been tracking pretty bullish for Kodiak Oil & Gas. A number of recent trading sessions have seen volume track in well above the three-month average daily action of 2.6 million shares. The most notable action was on last Thursday, when more than 4.5 million shares traded hands as the stock moved up and closed in the green by 10 cents.
Market players should now watch to see if volume continues to expand above 2.6 million shares as KOG makes its second attempt at clearing $4.34 to $4.55 a share. If volume does expand, and the stock moves above those levels, then I would look for continued upside in this stock. This stock is not cheap, trading at 15 times forward earnings, but if the natural gas sector is about to come into play, then look for traders to snatch up KOG for a short squeeze play.
The current short interest as of Oct. 29 for KOG sits at around 9% of the tradable float of 142 million shares. If the stock does break out, you’re going to see a short squeeze develop that could spark the bears to cover their bets and buy back the stock.
Another breakout candidate you should put on your radar is Energy Transfer Partners (ETP), a limited partnership based in the U.S. and engaged in natural gas operations. What I like about the breakout potential for this stock is that shares are only up 14% year-to-date, so there could still be plenty of room to the upside left.
If you take a look at the chart, you’ll see that shares of Energy Transfer Partners are setting up to challenge for a breakout trade above $52 a share. What I love about the action in Energy Transfer Partners is that the stock just recently broke out above $50.50 a share. One breakout tends to lead to another breakout and so on as strong stocks like ETP bust through their overhead resistance levels with ease. Think of it as momentum taking over and demonstrating that the stock is just too strong to be stopped by the sellers. Put yourself in the mind of the seller for a moment: If you can’t stop the stock’s rise at $50.50, then why assume you can at $52.
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If ETP manages to take out $52, then I would look for the stock to test the next area of previous overhead resistance at around $54 a share. A move above that level should set this nat gas play up nicely to challenge its all-time highs at around $63 a share. If you want to see where support is on the stock then just take a look at the trendline I drew on the chart that shows $48 as the key level to watch.
It’s possible that the sellers might have lost control on this stock in the short term due to the fact that the fundamental picture is starting to look very bright for ETP. The company just reported a very strong third-quarter result that showed higher natural gas storage and transportation fees. If natural gas can finally start to climb out of the basement, then that could be just the catalyst to set this stock off on a new bull trend higher.
It’s also worth noting this stock pays a bountiful annual dividend of $3.58 a share which equates to a 7% dividend yield. That’s not a bad payout to collect as you wait for a potential breakout to materialize in Energy Transfer Partners.
To see more breakout action in stocks, check out the Breakout Stocks of the Week portfolio on Stockpickr.
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.