Seeking out breakout stocks is probably one of the most-favored techniques among active investors. The logic behind this kind of stock selection is to determine those are trading within a narrow band. These stocks are to be bought as soon as they move above this channel and sold when they fall below. In case a stock moves above this band, it usually gains momentum.

At the same time, market watchers warn against incorrectly timing such a move. This is because there is a significant risk of identifying stock movements as breakouts even when this is not the case. However, when utilized judiciously, this strategy yields formidable gains, which is the reason why it remains popular.

Zeroing in on Breakout Stocks

In order to select the right breakout stock one has to first calculate its support and resistance level. A support level is the lower bound for stock movements while a resistance level refers to the maximum price which it trades within over a considerable period.

In other words, the 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.

Has a Breakout Really Occurred?

The central risk which accompanies such a strategy is that the decision to buy an apparent breakout candidate has been incorrectly timed. When a stock moves above the resistance level, it should be a highly prized commodity for traders. However, whether such a breakout is at all genuine is another matter altogether.

For breakout to actually happen, the stock’s earlier resistance barrier should become its new support level. This only happens if the trading channel that has been established is tested by observing long-term price trends. The strength of the support and resistance levels can be ascertained only through such a study. Despite the risk of misidentification, correctly identifying such stocks can yield considerable returns, even at a price which may not seem attractive at first glance.

Screening Parameters

• Percentage price change over four weeks between 10% and 20% (Stocks which are showing considerable price increases, but whose gains are not excessive.)

• Current Price /52-Week High greater than or equal to 0.9 (Stocks which are trading 90% close to their 52-week highs.)

• Zacks Rank equal to #1 (Only Strong Buy stocks can get through.

• Beta for 60 months less than or equal to 2 
(Stocks which move by a greater degree than the broader market but within a reasonable limit.)

• Current price less than or equal to $20 (Stocks which are reasonably priced.)

These criteria narrow down the universe of over 7892 stocks to only 6.

Here are the top five stocks that meet these criteria:

Cherokee Inc. (CHKE - Free Report) is a marketer and licensor of Cherokee and Sideout brand products, is continuing its negotiations for domestic and international licensing contracts covering multiple categories of merchandise. Cherokee’s average EPS surprise over the last four quarters 165.7%.

Autobytel Inc. (ABTL - Free Report) is an internationally branded online automotive commerce company that provides consumers with automotive solutions throughout the lifecycle of vehicle ownership. Avid Technology’s average EPS surprise over the last four quarters is 42%.

Alpha and Omega Semiconductor Limited (AOSL - Free Report) is engaged in designing, developing and supplying a broad range of power semiconductors globally, including a portfolio of Power MOSFET and Power IC products. Alpha and Omega Semiconductor’s average EPS surprise over the last four quarters is 272.5%.

Renewable Energy Group, Inc. (REGI - Free Report) is a biodiesel manufacturer and marketer. Its average EPS surprise over the last four quarters is 13.4%.

SolarEdge Technologies, Inc. (SEDG - Free Report) provides inverter solutions for solar photovoltaic installations. SolarEdge Technologies’ EPS surprise over the last four quarters is 13.3%.