For the uninitiated, a stock that hits a new 52-week high seems to be announcing an imminent fall in price. The initiated, however, know that the new high is a powerful buy signal that attracts investors. It goes against most people's instinct to buy something that continues to increase in price as we are continually told to buy low and sell high, but understanding why this belief can be a fallacy requires a bit of technical analysis.
A trend is a pattern of price movement for a stock that generally falls within a certain range. When a stock rises above its 52-week high, it's developing a new pattern and makes the old trend obsolete. New trends based on fundamental reasons, such as news releases or beating expected earnings, can be sharp and long lasting.
One of the most powerful forces influencing stock prices is momentum. As new highs are hit, more investors flock to the popular stock, causing the price to rise even higher. The buying pressure builds up and smashes through any resistance barriers, as few people are willing to sell as prices continue to increase. This effect is particularly powerful in growth stocks, as a level of exponential momentum is already expected.
New Support/Resistance levels
Support and resistance levels are among the most common technical indicators investors use when determining price ranges for a stock. After a stock breaks through a 52-week high, it automatically creates a new support and resistance level. A new price target is set by subtracting the 52-week low from the 52-week high and then multiplying the figure by the Fibonacci number of 1.618. By adding that to the 52-week low price, a new price target has been created.
While a new 52-week high can be taken as positive signal for investors, it does not excuse them from performing proper due diligence. Fundamental analysis of how a company operates and profits is still essential in determining whether a stock should be bought or not. Performing basic research and understanding market sentimentality can paint a clearer picture of a stock's future price movement.
Video of the Day
- The Journal of Finance; The 52-Week High and Momentum Investing; October 2004
- Getting Started in Fundamental Analysis; Michael C. Thomsett
- Stockbyte/Stockbyte/Getty Images