When the trend is strong, there could be either trend-following or trend-reversal opportunities at a stock’s 52-week highs and lows. Using our backtest file, you can measure the effectiveness of these strategies and make informed decisions. In the article below, we’ll tell you more about how you can use backtests on new stocks’ 52-week highs and lows to trade options. Also, our free backtest file is available for everyone at the end of the article.
Key takeaways
- A new stock’s high or low may both indicate potential trend-following and trend-reversal opportunities.
- Using our backtesting to measure the effectiveness of 52-week high and low strategies can help traders identify patterns and make informed trading decisions.
- We give you a free backtest file to help test this strategy. You can edit the predefined scans on our options screener to match the trend-reversal or trend-following strategy you prefer.
Using New Highs and Lows for Trading
It is rather intuitive to use an indicator like 52-week highs and lows to gauge a stock’s performance, but let’s break down exactly what that means and how it can be beneficial for trading options.
Our Indicator
The 52-week highs and lows indicator marks theh ighest and lowest prices that a stock has traded at during the past year. This range helps traders understand the volatility and performance of a stock within a specific timeframe.
Measuring Trend and Stock Momentum
- Identifying Trends: The 52-week high indicates the peak price level a stock has reached, while the 52-week low shows its bottom price. These points are crucial for spotting trends. If a stock consistently hits new 52-week highs, it suggests a strong upward trend and positive momentum. Conversely, repeated 52-week lows indicate a downward trend and negative momentum.
- Momentum Insights: Stocks reaching their 52-week high (or low) often attract attention from traders looking to capitalize on the positive (or negative) trend. Understanding these movements can offer insights into market sentiment and future price action.
Importance of Evaluating New Highs and Lows in Trading Credit Spreads
Evaluating 52-week highs and lows can significantly improve your timing when trading credit spreads. Here’s how:
- You could use this indicator as a trend reversal hint: By analyzing these indicators, you can better time your entries and exits. For instance, if you believe a stock has been moving up for too long and has recorded a new 52-week high, you may consider it as overbought, and you may open a credit spread to profit from a downward correction in prices. The idea can also work on those stocks that have recorder a new 52-week low and are now oversold: if you think the company behind the stock is solid, these moments can give you good credit spread opportunities.
- You could also use this indicator as a trend confirmation signal: If, on the other hand, you feel there’s a good reason for a recent strong trend (either up or down), and that this trend is likely to continue, you may see a new 52-week high or low as a confirmation that the market’s movement is solid, and a credit spread in the same direction as the general trend may be a good idea.
These indicators allow for better risk management by identifying key support and resistance levels. Knowing these levels helps set realistic profit targets and stop-loss points, reducing potential losses.
How to Use the New Highs and Lows Effectively
- Combine with Other Indicators: While 52-week highs and lows are helpful, they are more powerful when combined with other technical indicators like moving averages or RSI (Relative Strength Index). This combination can provide a more comprehensive view of the market.
- Historical Comparison: Look at how the stock has reacted historically when hitting its 52-week highs or lows. Patterns often repeat, and understanding this history can guide future trades.
- Market Sentiment: Pay attention to broader market trends and sentiment. Sometimes external factors drive stocks to their 52-week highs or lows. Being aware of these influences can prevent misinterpreting the data.
Our Idea: Leveraging New Highs and Lows to Gain an Edge in Trading Credit Spreads
We always tell you how we are options traders ourselves, looking for new ideas to improve our trade success rate. We normally discuss a trade idea, backtest it, and then, if the results are really good, we share it with our readers. Here’s our latest idea: leveraging 52-week highs and lows to gain an edge in trading credit spreads.
Trend Following and Trend Reversal Strategies
- Trend Following: When a stock reaches a new 52-week high, it often signals strong upward momentum. By following this trend, you can capitalize on continued bullish movement. Consider using bullish strategies like bull put spreads when a stock is at its 52-week high.
- Trend Reversal: Conversely, stocks hitting their 52-week low might be poised for a rebound. This presents opportunities for trend reversal strategies. Bear call spreads can be profitable if you anticipate a bounce after reaching a 52-week low.
Consider the Benefits fo This Strategy
- Better Market Timing: Evaluating 52-week highs and lows can help you time your trades more effectively. Recognizing when a stock is at these critical points allows you to enter or exit positions at optimal times.
- Informed Decision Making: These indicators provide valuable insights into market sentiment and potential future movements. You can make more informed decisions by understanding whether a stock is trending up or down.
How to Trade Credit Spreads Based on New Highs and Lows
Trading credit spreads based on new highs and lows can be a powerful strategy. Here’s how you can leverage this approach to optimize your trades.
Trend Following Strategy
Let’s say you find that MMM has recently hit a 52-week high, as you see below (the blue points represent 52-week lows, while the red ones represents the highs):
It’s Monday, and through our options screener, you spot a bull put spread opportunity on MMM with options expiring on Friday. MMM is trading at $127.16. You could buy a $121 put and sell a $125 put, as found on our options screener:
In this case, you would be aiming for a maximum profit slightly above $100 if MMM closes above $125. Your breakeven price would be $123.98, and the potential loss is roughly $300 if the trade goes against you.
Our backtest indicates that MMM’s price tends to vary between -2% and +2% four days after hitting a 52-week high, as you see below:
As you have probably already seen in similar backtest-related articles on our blog, the blue line represents the average movement for MMM price 4 days after hitting a 52-week high, the black line is the average movement of MMM on an average 4-day period, and the blue area indicates the 75% confidence interval for the analysis.
Although you need MMM to decline by more than 2% to incur a loss, historical data shows MMM moved up in 58.11% of cases in the four days following a new 52-week high (this is another piece of evidence you can find from our backtest file).
This suggests that, statistically, the odds are in your favor. However, given the -2%/+2% range, the indicator can be noisy. Therefore, consider combining this analysis with other technical or fundamental indicators to strengthen your decision-making.
Trend Reversal Strategy
If your analysis suggests bearish tendencies for MMM, you might opt for a trend reversal strategy. Suppose you notice that our options screener tells you that MMM has a fundamental score of 5/10, and that your independent research confirms this view. In such a scenario, you could use the same 52-week high event to implement a bear call spread instead of a bull put spread.
In this case, you’d buy a $135 call and sell a $130 call. Let’s say you want more time for the trade to be profitable, so you choose an expiration date 25 days out instead of just four days:
Running the backtest with this extended timeframe would be prudent. With this setup, you aim for a profit above $200 if MMM closes below $130. The maximum potential loss is slightly less than $300 if the stock goes above $135, and your breakeven point is $132.22.
Both strategies leverage the insights gained from analyzing a 52-week high:
- Bull Put Spread: Use this when you expect the stock to continue its upward momentum.
- Bear Call Spread: Opt for this if you anticipate the stock will reverse its trend.
This approach allows you to profit from both trend-following and trend-reversal opportunities. Combining these strategies with additional market analysis tools can help you make informed, data-driven trading decisions. Of course, this type of reasoning applies to new 52-week lows (in a perfectly specular way).
Now that you understand the output of the analysis, the next section will tell you how you can perform this type of study with our free backtest file.
Using Our Backtest File
There are a few simple steps you need to follow to run the analysis described above. Let us tell you more about the process.
Go to the scanner
Start by finding a trade. We offer two predefined scans to spot 52-week highs and lows, both covering the trend following case. If you feel like you should go for a trend-reversal strategy, you can easily edit the provided scans to create your own version and satisfy your needs. Use these scans as a confirmation (or disproof) of your independent analysis.
For example, if you are bullish on LVS, which has just hit a series of 52-week lows, you could find a bull put spread opportunity such as this one:
LVS is trading at $37.33, so you may want to buy a $34 put and sell a $38 put expiring in 25 days. As you can see above, we’d be talking about a roughly $70 profit and a loss above $300. The profit ratio is against you in this type of trade, so you really want to be confident in your analysis before adding this spread to your portfolio.
Enter the details in the backtest
Input the ticker, the starting year for the analysis, and the days for your analysis into the backtest file. For LVS, set the starting year to 2010 to ensure a large dataset. Assuming your options expire in 25 days, enter “25” in the days_after_high_low field. This is what you should have:
Analyze the output
Review the results. The backtest will provide insights into how the stock has historically moved after hitting 52-week highs and lows. This data will help you make informed trading decisions. In the next section, we will comment on the results obtained from this process.
A Real Trade Idea for a Credit Spread Based on Recent Highs and Lows
Let’s continue with our trend-reversal trade idea on LVS. The first thing you’ll see from our backtest is the historical price chart with new 52-week highs and lows highlighted (blue = new lows, red = new lows):
Note how LVS has a tendency to record a series of lows before moving back up, and observe that the latest 52-week lows came after a series of previous lows. This pattern suggests that a trend reversal strategy might be effective here.
Additionally, consider the evidence that in the 25 days following a new low, LVS’s price moved further down only 36.71% of the time. Why does this matter? Look at the bar chart below, which shows how many times LVS moved lower in the 25 days following a new low, year by year:
The long-term average is 36.71%, yet, in 2024, this happened 100% of the time. This anomaly looks statistically odd, making it rational to expect that this percentage will decrease by the end of the year. Therefore, a trend reversal trade on the latest low appears promising.
However, remember how noisy this indicator can be by itself. The chart below reveals that the confidence interval for the average variation in LVS prices after a new 52-week low is quite wide, ranging from -10% to +15%:
This wide range signifies that while the indicator provides useful insights, it should be combined with other tools for a more reliable analysis.
Methodology and Limits of Basing Your Trades on 52-Week Highs and Lows
As a final remark, let’s look a little bit more into the methodology and limits of using 52-week highs and lows in trading. The 52-week high represents the highest price a stock has reached in the past year, while the 52-week low marks the lowest. This range helps in trend analysis and gauging momentum in credit spread trading.
Strengths
- Trend Analysis: Spotting new highs and lows can help identify potential entry and exit points by highlighting significant price movements.
- Market Sentiment: These indicators reflect investor sentiment, providing clues about future price action.
Limitations
- Noise: Backtests often show results ranging from +15% to -10% after hitting a 52-week low, making it a noisy indicator.
- Overreliance: Using only 52-week highs and lows can be risky. Combine this with other technical and fundamental analyses for better accuracy.
