How To Trade Stocks: Breakaway Gaps And The Art Of The Breakout

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A breakaway gap is the quintessential breakout.

Typically event-driven, such as a strong earnings report, these price gaps can send a stock catapulting out of a good base. Why do they occur? Buying demand surpasses supply at the current price so much that the stock has to rise enough to convince holders to sell their shares and match the heavy demand.

By the close of trading on a gap-up day, it's not unusual to see a leadership-quality stock rise at least 20%. Volume tends to surge well above average. It leaves you with no doubt that this stock is going higher, much higher.

Let's take a look at LinkedIn back in 2013. The social networking site for professionals and recruiters debuted in May 2011. Five years later, it got bought out by Microsoft ( MSFT ) in June 2016.

LinkedIn had a phenomenal fundamental story. Large earnings and sales gains confirmed that thesis.

On Jan. 10, 2013, LinkedIn broke out of a classic 16-week cup-with-handle base with a 117.42 buy point. The base's positives included six consecutive up weeks on the right side of the base and a three-weeks-tight pattern within the handle. In the most recent quarter, earnings and sales were up a whopping 267% and 81%, respectively, vs. a year ago.

On the breakout day, the stock rose almost 4%. Volume increased 54% above its 50-day average. With an earnings release several weeks away, the stock meandered in and out of the 5% buy range until it launched 21% higher on Feb. 8. Volume surged more than 600% above average as institutions flooded into the stock.

There is a direct correlation between power and distance; the more power at the start, the higher the stock can go. From the close of trading on its breakaway gap, it ran up another 34% before the stock formed a new cup base. Even at all-time highs, the stock had plenty of upside potential.

If a stock gaps up so hard that it doesn't trade within 5% of the proper buy point, you may go ahead and buy shares as close as possible to the opening price. But make sure it has the fundamentals to be a true market leader. It should be No. 1 in its industry group, and the market should be in a young, new confirmed uptrend. The Big Picture column gives you a sense of the market's current stage.

Since we're in earnings season, it is even more important to keep an eye on leading stocks and their earnings announcement dates. MarketSmith , an premium charting and stock screening product, provides lists that look for new breakaway gaps like the one made late on Jan. 25 this year by MarketAxess ( MKTX ).

Once again, an earnings surprise paved the way for this stock's big breakout. With a huge gap up out of a double-bottom base on Jan. 25, the stock surged past its 172.53 entry on volume 165% greater than average. The next day, the stock was extended; through Thursday's close at 188.10, MarketAxess moved more than 9% above that entry. (The above chart is a weekly chart; please see a historical daily chart at MarketSmith to see the actual breakout.)

Unless you're 'Johnny-on-the-spot,' you missed it.

MarketAxess rallied 22% to a high of 211.06 by June, enabling holders to lock in gains based on IBD's top offense-type sell rule .

That's why having access to MarketSmith and its 'Breakaway Gap' list, and other IBD lists, such as IBD 50 and Big Cap 20 , can be so instrumental to successful stock research.

( A version of this column originally published on Feb. 3, 2017, at )


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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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