TM editors’ note: This article discusses a penny stock and/or microcap. Such stocks are easily manipulated; do your own careful due diligence.

Possibly one of the most preferred methods for those using an active investing approach, selecting breakout stocks promises substantial returns. This approach involves identifying those stocks whose prices are varying within a narrow band. If the price of the stock falls below this channel, it could be the best time to sell off 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.

Identifying Breakout Levels

The key to this strategy is calculating the support and resistance levels of a stock. The floor of a stock’s trading channel is its support level and it should be sold as soon as it threatens to fall lower. On the other hand, the resistance is a stock’s breakout level and it can gain substantially if it breaks the resistance level.

When a stock is close to its support level, demand is literally hitting the floor. On the other hand, demand rises when it is breaching its resistance level, signaling the right time to make a lucrative addition to your portfolio. The idea is to pick stocks which have just broken above their resistance barriers or are very closing to doing so.

Verifying Whether It’s for Real

Stocks which have breached their resistance level should ideally be in high demand among traders. But the test of whether this is a genuine breakout is whether 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.