Among the favorite methods for those utilizing an active investing approach, zeroing in on breakout stocks offers the promise of above-average returns. The process involves identifying those stocks whose prices are fluctuating within a narrow band. If the price of the stock falls below this channel, it could be the best time to sell of this stock. However, the best time to buy a stock as per this strategy is when it is about to break above this trading band. Such stocks offer the prospect of impressive gains.

Spotting a Breakout Stock

The first step to selecting the right breakout stock is to calculate its support and resistance level. A support level is the lower bound for stock movement while a resistance level refers to the maximum price which it trades within over a considerable period.

In other words, demand for a stock is at its lowest at its support level, which means most traders are willing to sell it. At the resistance level, most traders are willing to go long on the stock, which means that they would like to add them to their portfolios. The key to identifying breakout stocks is to zero in on those that are on the verge of a breakout or those that have just broken above the resistance level.

Verifying Whether it’s For Real

Stocks that have breached their resistance levels should ideally be in high demand among traders. But the test of whether this is a genuine breakout is when they go on to attain higher prices and the old barrier becomes a new support. This is why it is important to determine whether a long-term price trend is about to emerge.

Only a study of long-term trends can determine whether the existing trading channel has been breached effectively. This indicates the strength of the support or resistance levels. If you can identify the effective channel for a stock, picking it even at a not-so-reasonable price would give you significant returns.

Here are the top five stocks that meet our criteria:

VIVUS, Inc. (VVUS - Free Report) is a biopharmaceutical company developing innovative, next-generation therapies to address unmet needs in obesity, diabetes and sexual health. The stock has a Zacks Rank #1 (Strong Buy) and its average EPS surprise over the last four quarters 233.7%. 

Diversified Restaurant Holdings, Inc. (SAUC - Free Report) is the creator, developer, operator and franchisor of ultra-casual restaurants and bars. Diversified Restaurant Holdings has a Zacks Rank #2 (Buy) and its average EPS surprise over the last four quarters is 45.8%.

Qumu Corporation (QUMU - Free Report) provides enterprise video solutions. Qumu Corp has a Zacks Rank #2 and its average EPS surprise over the last four quarters is 21.7%.

MiX Telematics Limited (MIXT - Free Report) is a provider of fleet and mobile asset management solutions. It has a Zacks Rank #2 and its average EPS surprise over the last four quarters is 97%.

Aerohive Networks, Inc. (HIVE - Free Report) designs and develops a cloud-managed mobile networking platform that enables enterprises to deploy a mobile-centric network edge. Aerohive Networks has a Zacks Rank #2 and its average EPS surprise over the last four quarters is 22%.