How To Trade A Stock After It Hits An All-Time High

The markets are in unchartered territory, and some of blue chips such as Netflix, Inc. NFLX and Berkshire Hathaway Inc. are there too. The euphoria of an index/stock hitting an all-time high usually triggers fears of a pullback (falling back of a price from its peak) or correction (a pullback quantified as at least 10 percent from the peak) or even a reversal (a positive or negative change against the prevailing trend).

The former two are generally considered temporary price declines interrupting an uptrend, suggesting a slight pause in the upward momentum, while the latter is a trend reversal quite fittingly. How does a trader position himself/herself when considering a holding, which has hit an all-time high? Is a buyer justified in assessing a stock that is at a peak? Benzinga explores the opportunities and risks in trading these high fliers.

Cramer's Take On Buying Stocks In Record Territory

Former hedge fund manager and CNBC's Jim Cramer offers a very simplistic approach. A stock could move to new highs along with a market that has gone through the roof, or alternatively, a stock that has an inherent momentum breaks to a new high even as the market is in doldrums.

Either way, Cramer recommends buying the stock. However, it is not as simple as it sounds. Cramer suggests that the stock has to tick a few boxes for it to remain on his radar. The stock should continue to hit new highs amid intermittent pullbacks (make a new high and then pullback, make another fresh high and pullback). Cramer sees momentum in such stocks.

In that case, when are we to buy the stock? Cramer has an answer for this question. While shunning the high, Cramer aims to buy the stock at levels representing about 5 percent pullback from the earlier all-time high. And now the follow up: Crammer recommends doing a thorough homework on the reasons for the uptrend and the level at which we can ring the cash register. Sounds simple, isn't it?

Another Take On Record Run

The new high is often considered as a resistance level that is tough to overcome. Those who are already bought into the stock either look to sell all or part of their holdings or shy away from adding to their positions. Those considering to take a position in the stock may hold off. Owing to these, the stock could get compressed at this level.

However, if positive tidings or sound fundamentals have driven the stock to the new highs, eventually skepticism may give way to optimism, manifested by buying, pushing the stock to new highs accompanied by huge volumes. Now, the compressed stock typically clocks gains in excess of the average market.

Few Rules To Apply While Evaluating A Stock In Record Territory

Investopedia contributor Alan Farley recommends dynamic strategic shifts in risk management and profit objectives at each phase of an uptrend. Some of the rules he emphasizes include:

1.Categorizing The Breakout's Progress

The stock thrusting above its previous high is in action phase and when this stock comes back down to a new support it is in the reaction phase. Once the stock recoups all the losses and breaks out to a new high, it is in the resolution phase.

Farley recommends avoiding new long exposure in the testing phase except at the range extremes. Those already positioned in the stock have to set stops in a bid to minimize losses.

2. Review Pattern Structure Into The Breakout

If the pattern before the breakout shows price running straight up into the breakout level from a deep low, without a consolidation pattern, a trader has to be defensive in his approach. On the contrary, if a basing pattern is formed below the breakout level, it is construed as bullish, as the sturdy price action builds strong support that is unlikely to be violated during the reaction phase.

3. Find Your Profit Protection Price

If the uptrend reverses, Farley suggests setting a profit objective for yourself, say a percentage gain or a psychological level, as we now shift into profit protection and enhancement mode.

4. Consider Additional Exposure

Adding onto position could be done when the stock falls into an advantageous risk/reward location, like a selloff into a weekly or monthly moving average or when it clears a fresh barrier like a rising highs trendline or Fibonacci harmonic.

The next time you see a stock racing to an all-time high, these tips may come in handy and help maximize your profits!

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