How to trade stocks that have reached historic highs

Each phase of an uptrend has unique factors that require strategic changes in risk management and profit goals. This is especially true when a stock hits a new high that has not been traded in its long-term history. This scenario can create wealth quickly but requires special technical rules to capitalize on the mechanisms involved.

The dynamics change when a title hits uncharted territory. The new high impression rate signals very favorable conditions in which there is no oversupply in the form of shareholders who must sell at a loss or take revenge. This unbalanced equation can result in quick wins that often exceed logical price targets, but can also generate unexpected behavior that encourages emotional decision making.

Resistance disappears when a title hits an all-time high, but hidden obstacles remain, ready to surprise reckless longs with reversals and teardowns. While the breakout completes the digestion of the previous supply, the security undergoes additional testing that can last for weeks or months. This process has the power to trigger large losses which can be avoided with the first special rule, which categorizes the positioning of the uptrend versus the breakout.

Rule # 1: categorize breakout progress

Breakouts to new heights tend to unfold in three distinct phases. First, the price breaks through resistance, attracting above average volume. This marks the “action” phase. Eventually the rally’s momentum waned, with weak hands closing in on the rally highs. This imbalance triggers the second phase or “reaction”, which tests the durability of the break. Support holds, triggering a rally above the previous high which confirms the breakout, or it turns into a swing of failure. The two results complete the third phase or “resolution” phase.

Image by Sabrina Jiang © Investopedia 2020

Ambarella, Inc. (AMBA) broke through resistance at $ 36 in September and hit an all-time high in the mid-1940s. This phase of action gave way to an opposing reaction phase which brought the price back to a low. new support and undercut it for two sessions, shaking weak hands. The stock then recouped all of its losses and posted another streak of all-time highs, completing the resolution phase.

The accumulation / distribution as measured by the equilibrium volume (OBV) determines the path of least resistance, promoting rapid upward resolution when it reaches new highs and deforms when it lags behind. price trends. This makes sense because a stock at an all time high should generate widespread interest which will translate into enthusiastic buying pressure. When it doesn’t, the trend must stop and find a missing sponsorship or gravity can take control, unwinding the breakout.

Sidelined participants should avoid further long exposures during this testing phase, except at the extremes of the range where the risk / reward equation will work in their favor. These opportunities usually come in the form of withdrawals to a new medium. Those who are already positioned have no choice but to set stops and let the market decide their fate.

Rule # 2: Examine the Pattern Structure in the Break

Now categorize the price structure leading to the breakout. Take defensive action when a) the breakout marks the third rally wave from a deep low in the previous range or b) the price rises directly into the breakout level from a deep low and continues without building a consolidation model. Both scenarios increase the likelihood that the rally wave above the breakout level will exhaust the uptrend and cause a large correction.

A more bullish price structure will show a base setup below the breakout level but not too deep into the previous trading range. Look for those price bars for cutting out rounded or square bottoms that show multiple failed attempts to break the backing and bring down security. This solid price action creates strong support that is unlikely to break during the inevitable reaction phase.

Rule # 3: locate hidden resistance levels at new highs

Image by Sabrina Jiang © Investopedia 2020

Next, stretch a Fibonacci grid from the bottom of the trading range to the breakout level, and mark the harmonic extensions at 1.270, 1.618, 2.000 and 2.618, as shown on the Mylan NV (MYL) chart. Then look for the first major high after the breakout to exceed 27% of the distance between the low price and the breakout price, or the 1,270 harmonic. A high above this level increases the chances of a successful breakout, while failure to reach this level increases the chances of failure.

Higher harmonic levels will mark hidden resistance as the uptrend strengthens and can be used to take profit, unless a buy and hold strategy intends to hold the position indefinitely. The highest extension at 2.618 marks a stretch target that can signal a significant high, so at least consider re-evaluating profit targets when a position hits that level.

Now connect previous highs that line up at three or more points, indicating trend lines of ascending highs that mark hidden structural barriers. Beware if you find trendlines that have contained the progression of the uptrend over the past six to 12 months as they exhibit weak momentum that could undermine the current rally. On the flip side, consider additional exposure when the uptrend crosses one of these lines, as this indicates accelerating momentum.

Rule # 4: Find Your Profit Protection Price

Suppose security has confirmed the escape and removed all hidden barriers. Special rules are now changed to protect and enhance benefits. Start by setting a minimum profit which will be taken aggressively if the uptrend reverses. You can work out this number using a simple winning percentage such as 10%, 20%, or 50%, or a psychological level such as $ 5,000, $ 10,000, or $ 25,000. Technically-oriented market players can set a mental stop that meets these goals or just pick a real number.

Avoid physical shutdowns, because the flash crash of May 2010 showed us that they can be targeted at any time by the predatory algorithms that move modern markets. There is no reason to waste all your hard work, make a big profit and then lose it when chaos hits the ticker, as it regularly does. Just make sure your magic number is well clear of the current price action and will only be hit if the worst case scenario occurs.

Rule # 5: consider additional exposure

Additional exposure can raise your profit to a new high, but buying at the wrong time will have the opposite effect, destroying the profit you have already accumulated. As a rule of thumb, only add to the position when it falls into an advantageous risk / reward location, such as a massive sell off in a weekly or monthly moving average, or when it breaks a new barrier such as a trendline of rising highs or a Fibonacci harmonic. These general scenarios will rarely occur, often giving only one or two favorable entry points in a year.

The bottom line

A stock at an all-time high may exceed logical price targets after finally escaping gravity at the previous breakout level. Apply special business rules to these uptrends, avoiding price spikes in uncharted territory while being careful to avoid hidden traps and protect core profit.

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