Detecting Breakouts In Low-Priced Stocks

Las Vegas Or Los Nasdaq?

by Markos Katsanos

Have you ever seen a low-priced stock in your watchlist go up by more than 50% in a day and wished that it had been in your portfolio list instead? Here's a method for picking stocks before they break out.

Most traders and market technicians avoid penny stocks. In fact, their stock screening usually includes a filter to eliminate stocks priced at $5 or less. The most common reason cited is that technical analysis does not apply to penny stocks. But is technical analysis really irrelevant where penny stocks are concerned? I decided to investigate.


For my research, I compiled a list of 50 stocks priced below $3, all trading on major US exchanges: the Nyse, Nasdaq, or Amex. I made a note in an Excel spreadsheet of the values, direction, and (where appropriate) divergence of 30 different indicators or statistical metrics, one day before a major breakout. I used indicators with their default values plus two additional time periods.

The average breakout of the sample was 150% in the next few days; the minimum considered for this study was 40%. More than half of the indicators were found to have no significant predictive power and, to eliminate unnecessary work, were dropped out halfway through the research. The remaining indicators were evaluated empirically and statistically, and the best were included in a MetaStock system test. Indicator parameters were optimized in further out-of-sample testing. Any recognizable formations and their duration were also noted. The system was then tested on 100 penny stocks.

Of course, there is no guarantee that what worked in the past will work just as well in the future, but despite some unavoidable casualties, the overall results were satisfactory.

Some of the stocks tested returned more than satisfactory results. One stock -- Vion Pharmaceuticals -- returned an unbelievable profit of more than a quarter of a million dollars on $10,000 of initial equity.

The following indicators, chart formations, or statistical metrics were found to have significant predictive power of the subsequent breakout.


Chart formations

The majority of stocks broke out of a base formation. Breakouts from pennants or flags were excluded from this study, as the breakout setup tended to vary substantially from typical stocks in the sample. These should be researched independently, perhaps in a future article.

No other distinguishable formation was observed except for a couple of uncompleted cup-with-handle formations. The base duration varied from 20 to 170 days, with a 70-day average and a 40-day standard deviation. The short-term direction, as quantified by the linear regression slope, was slightly negative but tended to increase with age. Most of the stocks were in a long-term uptrend, and in fact 36 stocks (72% of the total) were in an uptrend for the 170 days before the breakout.

  ...Continued in the January issue of Technical Analysis of STOCKS & COMMODITIES

Excerpted from an article originally published in the January 2005 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.

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