Each stage of an upswing has its own set of characteristics that need strategic modifications in risk management and profit goals. This is particularly true when a security rallies to a new high not seen in its long-term history. This situation may swiftly accumulate riches, but it needs unique technical guidelines to profit on the mechanisms at work.
- Each stage of an upswing has its own set of characteristics that need changes in risk management and profit targets.
- When a security rally reaches a new all-time high, it is critical to be ready to alter approach.
- New highs indicate advantageous circumstances in which there is not an overstock of shareholders who must sell at a loss or to break even.
- When trading all-time highs, some principles to remember include classifying the breakout’s development through stages, examining pattern structures into the breakout, discovering hidden resistance levels, determining profit protection pricing, and assessing extra exposure.
When a security enters unknown terrain, the mechanics of momentum alter. The new high print indicates exceptionally favorable circumstances, with no overstock in the form of stockholders who must sell at a loss or break even. This unbalanced equation may lead to quick gains that often outperform realistic price expectations, but it can also lead to unexpected behavior that stimulates emotional decision-making.
When a security reaches an all-time high, resistance fades away, but hidden barriers remain, ready to startle naive longs with reversals and shakeouts. While the breakout digests previous supplies, the security is subjected to further testing that might span weeks or months. This process has the potential to cause significant losses, which may be prevented by using the first special rule, which classifies the uptrend stance in respect to the breakout.
Rule #1: Categorize the Breakout’s Progress
Breakouts to new highs often occur in three stages. First, the price breaks through resistance, drawing higher-than-normal volume. This is the “action” stage. Rally impetus gradually dissipates, and weak hands enter around rally highs. This imbalance initiates the second or “response” phase, which evaluates the breakout’s resilience. Support either holds, initiating a rebound above the preceding high and confirming the breakout, or it fails and rolls over. Both results bring the third or “resolution” phase to a close.
In September, Ambarella, Inc. (AMBA) broke out above resistance around $36 and climbed to an all-time high in the mid-$40s. This action phase was followed by a counter-reaction phase in which the price was pushed back to new support and undercut for two sessions, shaking off weak hands. The security then recovered all of its losses and set new all-time highs, bringing the resolution phase to a close.
On-balance volume (OBV) dictates the path of least resistance, favoring swift upward resolution when it achieves new highs and whipsaws when it lags price development. This makes sense since a security at an all-time high should arouse broad attention, resulting in passionate purchasing pressure. If it doesn’t, the trend must halt and seek for the missing sponsorship, or gravity will take over, unraveling the breakout.
Participants who have been sidelined should avoid additional extended exposure during this testing period, unless the risk/reward equation favors them. These chances generally take the shape of pullbacks to fresh support. Those who are already invested have little option but to place stops and let the market determine their destiny.
Rule #2: Review PatternStructure Into the Breakout
Now classify the price structure before the breakout. When a) the breakout is the third rally wave off a deep low inside the preceding range, or b) price moves straight up into the breakout level from a deep low and continues without forming a consolidation pattern, take defensive actions. Both situations increase the likelihood that the rising wave above the breakout level would exhaust the uptrend and result in a significant drop.
A more optimistic price structure will have a basing pattern below the breakout level but not too much into the previous trading range. Look for rounded or square bottoms in these price bars, which indicate multiple unsuccessful efforts to break support and push the security down. This firm price action establishes solid support, which is unlikely to be broken during the inevitable response phase.
Rule #3: Locate Hidden Resistance Levels at New Highs
Next, draw a Fibonacci grid from the trading range’s low to the breakout level, noting harmonic extensions at 1.270, 1.618, 2.000, and 2.618, as shown on the MylanN.V. (MYL) chart. Then, following the breakout, wait for the first major high to surpass 27% of the distance between the low and breakout price, or the 1.270 harmonic. A high that exceeds that level increases the chances of the breakout succeeding, while failing to reach that level increases the chances of failure.
Higher harmonic levels will identify hidden resistance as the uptrend gains strength and may be utilized to take profits, unless a buy-and-hold strategy plans to retain the position permanently. The highest extension, at 2.618, is a lofty target that may indicate a large top, so consider re-evaluating profit targets when a trade hits that level.
Connect preceding highs that line up in three or more places to construct rising high trendlines that indicate hidden structural obstacles. Be aware of trendlines that have restricted upward advancement for the previous six to twelve months, since they indicate weak momentum that might weaken the present rise. Consider increasing your exposure when the uptrend breaks through one of these lines, since this implies expanding momentum.
Rule #4: Find Your Profit Protection Price
Assume that security has verified the breakout and removed all concealed obstacles. The special regulations are currently in profit protection and enhancement mode. Begin by establishing a minimum profit that will be aggressively taken if the rally reverses. This figure may be calculated using a basic percentage increase of 10%, 20%, or 50%, or a psychological threshold of $5000, $10000, or $25000. Technical market participants might set a mental stop that matches these requirements or just use a real amount.
Avoid using physical stops since the May 2010 flash collapse demonstrated that predatory algorithms that drive contemporary markets may attack them at any moment. There’s no need to let all your hard work go to waste by making a large profit just to lose it when the turmoil hits the ticker tape, as it often does. Just make sure your magic number is significantly away from current price movement and will be reached only if the worst-case scenario occurs.
Rule #5: Consider Additional Exposure
Additional exposure may accelerate your profit to a new high, but purchasing at the incorrect moment can have the reverse impact, erasing your profit. As a general guideline, only add to the position when it falls into a favorable risk/reward zone, such as a sell-off into a weekly or monthly moving average, or when it clears a new barrier, such as a rising highs trendline or Fibonacci harmonic. These broad-based situations will occur rarely, generally offering just one or two excellent entry moments in a year.
The Bottom Line
After finally escaping gravity at the preceding breakout level, a security at an all-time high may surpass rational price goals. Apply unique management criteria to these uptrends, staying out of the way as prices rise into unknown territory while avoiding hidden traps and protecting the main profit.
Investopedia does not provide tax, investment, or financial advice. The material is offered without regard for any individual investor’s investing goals, risk tolerance, or financial circumstances, and may not be appropriate for all investors. Investing entails risk, including the possibility of losing money.
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