A High-Volume Breakout Is Icing On The Stock Base

Investor's Business Daily

Once you've identified a growth stock with good fundamentals, a correctly shaped base and a clear , there's only one thing left to do: Watch for a .

A breakout occurs when a stock clears its buy point in that's at least 40% above its daily average. When that happens, the stock has turned a corner and has a good chance of racking up big gains — provided there's no significant change in the stock's fundamentals or the market's uptrend.

IBD research on chart patterns shows that a stock's price often accelerates when it clears its buy point in a properly formed base.

But a breakout in weak volume is typically a bad sign; it indicates that institutional investors probably aren't participating.

In such cases, the stock may keep basing, build a or go into a correction.

Watching the Relative Strength line can also help to confirm the breakout's strength. The RS line should be hitting , or at least rising strongly. It shows the stock is outperforming the S&P 500, and thus the broad market.

A falling or flat RS line is a warning sign because it shows the stock is a laggard. One reason for that could be that the base is third or fourth stage and the stock's rally is losing steam. Such late-stage bases are risky because they usually form after the stock has already enjoyed a long run-up.

Breakouts accompanied by weak volume or a lagging RS line should prompt you to keep a finger on the "sell" button to prevent taking a loss on the stock. Or, to be safe, watch to see if volume kicks in a day or two after the breakout before jumping in.

Of course, the Market Pulse box, located on page B2 of IBD most days, should indicate that the market is in a confirmed uptrend. And the stock should show strong and preferably accelerating profit and .

DryShips (DRYS), whose vessels transport dry bulk goods, began forming a nicely shaped cup base in January 2007. The buy point was 10 cents above the left-side high of the base, or 18.47.

Trading was tight and the stock's Relative Strength line ( please see a weekly chart on MarketSmith) was rising sharply as it cleared the buy point on Feb. 20 on double its average daily volume. The stock's Composite Rating was also a respectable 88 on the day of the breakout.

DryShips more than tripled in less than three months, hitting a high of 42.20 on May 15.

Keep in mind that while it may be tempting to buy a good-looking stock before it reaches its buy point, it's important to avoid doing so. That's because many stocks stall and then retreat just before reaching their buy points.

Also, a stock that closes below its buy point is waving a red flag. Such breakouts often end up failing, especially when the market rally is under pressure or going into a correction.

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