One of the most oft-repeated lines in investing is “buy low, sell high.” It makes perfect sense since that is, in essence, how to make money off the stock market. Many people took this adage and made it the central concept of their trading strategy. They scan for stocks wallowing in the deep end of their charts, entering only when they believe prices have reached their bottom. It’s a straightforward strategy best suited for cautiously optimistic traders and investors. But what if you wanted a riskier, more aggressive trading system? Well, you can simply take the adage “buy low, sell high” and turn it into “buy high, sell higher” This is the exact concept behind the 52-Week High Breakout Strategy.
52-Week High explained
The 52-week high is the highest price of a security or commodity in the last 52 weeks, i.e., the last year of trading. Traders and investors often ascribe significance to the 52-week high, such as:
Momentum indicator
Prices moving toward or close to the 52-week high are often seen as a bullish signal and a strong momentum indicator. Investors using momentum strategies can benefit from identifying these levels to set their proper entry and stop-loss prices.
Resistance level
Traders often see the 52-week high as a strong resistance level for stocks. Depending on their trading strategy and price predictions, they can use the price level as an entry for a long or short position.
Take-profit and profit-protection price
On the flip side, investors can use the 52-week high as their cue to exit their positions if they believe that the stock does not have enough momentum behind it to break through.
In this particular example, we can see a stock registering higher lows and moving close to its $12.00 resistance, possibly hinting at a significant upward movement. Should the price break through $12.00, traders can set their take-profit price at or near its previous 52-week high (yellow line). If the trader or investor decides to hold the position after a 52-week breakout, the price level can also be used as a stop to lock in their profits should prices reverse.
Confirming good fundamentals
As is often the case, companies that display solid fundamentals as their stock reach new highs are a good way to attract investors. Looking at the stock’s fundamentals is useful in figuring out if the breakout is a sustained upward move or a one-off event.
Market or industry overview
Seeing multiple companies reaching new 52-week highs can be taken as a sign of an overall bullish outlook within the market or industry.
The strategy
Consider the example above. The stock currently has a 52-week high of $4.81. According to the breakout strategy, any price movement close to or over that level can be seen as an indication of investor interest and strong bullish momentum.
Moving the chart further, we can see that the price broke through the 52-week high with a notable gap up, ending at a new high of $8.60. Traders can then buy the stock during the next trading session and set their stop-loss slightly beneath the previous 52-week high.
The importance of volume in the 52-week high breakout strategy
There are a lot of other indicators that you can use in conjunction with the 52-week high breakout, which we’ll talk about later. However, the most crucial indicator to consider is the stock’s trading volume. It can help to sort potential stocks and weed out false breakouts and unsustainable price movements.
Taking the previous example, we can see a sharp spike in volume during the day of the breakout. High trading volumes (relative to the stock’s previous volume average) during a stock’s 52-week breakout can be a positive indicator. It means that the market took notice of the price moving through its previous highs, and many investors decided to participate. This can also mean the market has accepted the stock’s new price level as its new valuation. In addition, higher volume can also mean that institutional investors like banks, hedge funds, mutual funds, and insurance companies are buying the stock in bulk.
You may also notice that the average volume after the price spike remained higher than the prior average. This suggests that investors and traders are still interested in the stock after the breakout and are willing to bet on its continued price increase.
Technical indicators to use with 52-week high breakouts
It is always best to use at least two indicators in your trading. This gives you more confidence in spotting and confirming signals. So here are the best indicators to use along with the 52-week high breakout:
Fibonacci Retracement
Breakouts over previous highs mean prices will be moving in new, uncharted territories, at least in the context of the year. Using Fibonacci Retracement is an excellent way to plot out new price levels to use as supports, resistances, and exits.
Relative Strength Indicator (RSI)
Another great indicator to pair with the 52-week breakout strategy is RSI. The indicator can provide signals for when the upward price move is losing its momentum. Again, it’s best to pair this with volume to identify clearer sell signals. For example, a trader can prepare to sell when RSI exceeds 70 and pull the trigger when it dips below 70.
Moving Averages/MACD
Moving averages or MACD can potentially help with trading 52-week breakouts. Since the averages are following the new prices, albeit in a lagging way, they can become reliable indicators for spotting when the price are about to reverse.
Chart patterns
Stock prices tend to move within recurring price channels. This is why chart patterns are great for identifying trend reversals and potential price movements, especially after breakouts.
Disadvantages of the 52-week high breakout strategy
As mentioned above, using 52-week breakouts in your trading offer potentially high profits but carries commensurate risks. It is also, like most indicators and strategies, far from foolproof. Here are some disadvantages of using the 52-week high breakout strategy.
High entry prices
There’s a good chance that you’re overpaying for an asset when using the 52-high as your buying guidance. This is especially true if not everyone is on board with the new stock valuations. Investors buying at high prices are also vulnerable during sudden price corrections or changes in market sentiments.
False breakouts
Not all 52-week breakouts are sustainable. Perhaps the volume isn’t enough to keep the prices up, or it was triggered by a one-off event and lost its steam. Failed breakouts can be very dangerous, as the failure to move through the strong resistance level can trigger frenzied selling. This can then create a domino effect that can push prices further down.
Common trading strategy
The 52-week breakout strategy is well-known and can prove both beneficial and detrimental to trades. Many investors will look out for these events, which can be used to solidify confidence in the trade. However, the same investors can significantly affect price action, and indecision can cause whipsawing prices.
No exit signals
As said before, 52-week highs are great for identifying potential entries for long positions during uptrends. However, when used exclusively, the strategy does not provide any exit signals. This can make investors overstay the trade and lead to reduced or even erased profits.
Closing thoughts
Trading using the 52-week high breakout as your guide can be a great way to bolster your profits. Just make sure that it suits your risk profile and that you account for its weaknesses.
This article Buy High, Sell Higher with 52-Week High Breakouts originally appeared on Rick Orford – Helping You Invest In Yourself.
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