Why You Should Buy Stocks At Record Highs
In the arsenal of trading tactics, buying new highs is one of the most powerful. Easy to say, but difficult to do. For one good reason: Instead of ‘buy low, sell high’, this tactic embraces ‘buy high, sell higher.’
Last week, I talked about Relative Strength in markets. You should buy stocks with good relative strength because relative strength tends to persist. Very often, prices can venture into uncharted territory for a long time.
Take Netflix (NFLX). After prices broke new ground in late 2013, the stock went rampant and generate new record highs year after year for five years!
Why New Price Highs Matter For Buying Stocks At All-time Highs
New price highs matter for many good reasons. First of all, stocks at record high attract media attention. It generates excitement. Look at all the excitement surrounding Ocado (OCDO) now. Second, new highs means all shareholders are sitting on profits. So most will hold longer. Third, new all-time highs suggest strong demand for that stock. Buyers are plenty and brokers are definitely bullish about the stock. Even if you do not understand what the company makes, at least you know everyone wants a piece of that stock. Think Bitcoin in 2017.
Tactics for buying at stock market highs
If you agree that new highs is a good buying tactic, how should you approach it? Two ways. One is to buy immediately. The other is to wait for a pullback. There are pros and cons in each case.
Chasing after a stock price at new highs means you are likely to pay up. But you are at least ‘in the game’, so to speak. Waiting for a pullback, however, creates a better entry point. But this pullback is by no means guaranteed to happen.
Other questions to consider when you buy stocks at new highs:
- Is this the stock’s first new highs? If yes, buy more.
- Stoploss procedure?
- Do you pyramid up? That is, do you buy more as price rise?
In stock markets, anything can happen can whatever reason. A stock will produce trends and patterns that are completely different to other stocks. For example, count yourself fortunate if you bought into Microsoft’s (MSFT) breakout at $40 in 2014 because its subsequent trend was so smooth (ie, shallow consolidations and persistent new highs). Apparently, its rally is not yet finished yet!
In contrast, look at JD Weatherspoon’s (JDW) trend below. It broke out at the same time as Microsoft in 2014, but it endured a multi-year consolidation before prices took off. Its returns are also far lower than that of MSFT’s. Tactically, it would better to take a loss here and move on to other better-performing stocks in 2014, and returned here in 2016.
Therefore, having a stop-loss strategy is must, because you will never know how a stock will perform after establishing new highs.
Not All New Stock Market Highs Are Equal
The last point worth stressing is this: Buying new highs after a five-year bull market entails a different risk-reward proposition to a stock that just made its first high. In other words, not all new highs are created equal.
Look at MasterCard (MA). Do you think the latest new high is less or more risky than the one in 2011? After a 7x increase in prices ($30 to $210), I would think more. This means I would avoid pyramiding here. The chance to do it was in the early phase of a stock’s breakout, not after a multi-year advance.
As a final note on buying stocks at new highs
The dynamics for new lows are exactly the similar to new highs – but in an opposite manner. When a stock makes new record lows, its bear trend is likely to continue until all available sellers have sold out. ‘Bad news,’ as Warren Buffet observes, ‘often surfaces serially: you see a cockroach in your kitchen; as the days go by, you meet his relatives.” By then, stock prices may have collapsed by 80%. So if you are going to panic about a stock, at least panic early!
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Jackson has over 10 years experience as a financial analyst. Previously a director of Stockcube Research as head of Investors Intelligence providing market timing advice and research to some of the world largest institutions and hedge funds.
Expertise: Global macroeconomic investment strategy, statistical backtesting, asset allocation, and cross-asset research.
Jackson has a PhD in Finance from Durham University.