How to Buy Low and Sell High
Even people who are not interested in investing have heard the phrase “buy low and sell high”. It’s a very simple principle that applies to every walk of life. If you buy an x amount of something when its price is low, and sell that same amount of that same something when its price is high – you can make a profit by simply identifying the right timing to engage in a transaction.
On paper, the strategy is sound. Particularly for stocks (if they are not dividend stocks) – that’s the whole point of buying them, to sell them at a later date and at a higher price. The problem is: you would need to time the market to achieve this.
While this may seem straightforward, it’s definitely not easy to pull off in practice, when you are dealing with financial markets – not in the least. Investors buying stocks and securities at a low price only to sell them once their price is high doesn’t always work in their favor.
But, that’s what we’re here to discuss today, and hopefully, give you some pointers that’ll help you do it successfully.
Timing the market
Let’s say the value of a certain stock is in a downward trend and investors follow this closely. How can you determine which point would be the most extreme (or lowest) for this given trend? Historical data, i.e. the benefit of hindsight, makes it fairly easy to pinpoint the cheapest selling price for any stock. But in the heat of the moment, who can really put their finger on the exact time of the trend reversal with full confidence? The short answer is no one.
The typical disclaimer novice investors get from an investing platform, a broker, or market analyst is: past performance is not a reliable indicator of future results. There is a reason they put such a notice in the field of view of their clients – these financial advisers would not like to be held accountable if their clients (potential investors) make an investment decision based on historical data, and this decision results in a loss.
This is one of the first recommendations new investors get: don’t try to time the market. It’s near impossible to do it with success on a consistent basis. Even if an investor somehow has foreknowledge of a major event with the potential to disrupt markets, it’s still hard to predict the manner in which this will actually unfold.
Forces that affect market movements
The movement of prices on the stock market is a complex issue. However, we will reduce it to its basic elements for the benefit of better understanding investing strategies. There are three major forces that affect stock market prices: the performance of the economy (and individual companies), big world events, and the herd instinct typical for the market floor.
If we use investment lingo, these same three categories can be termed: technical factors (the economy), fundamental factors (news on events), and market sentiment (what most traders do, how they feel in the trading environment).
Significant world events
Individual investors are not in a position to control major world events; they can only choose how to react to them. The list is long – markets are affected by:
- change of interest rates by the Fed;
- general performance of the nation’s economy;
- major events (like armed conflicts, acts of terrorism, health crises).
Sometimes, the effect of a specific change is felt within one industry while others remain unscathed. For example, let’s take the COVID-19 crisis into consideration. While tourism tanks, the IT sector, in general, is not affected. If an investor knew back in December of 2019 that the next year(s) would be marked by planet-wide lockdowns as a response to the spread of a new virus, then they would definitely hurry to sell their stocks in airline companies and buy shares in pharmaceutical companies, right?
Company performance
In essence, this refers to the influence of company results on stock prices. It consists of sifting through financial data (in the strict sense of the word), like tracking performance reviews and fiscal reports, but not exclusively so.
For example, if an important employee of a given company decides to retire or step down from their position, this can have an effect on financial prospects. Also, the promotion of a new product (or product line) can also bring about big change. Investors may find it difficult to predict these effects too. For instance, even if a competent CEO left, what if the company recruited a suitable replacement for them?
Herd mentality
People just can’t help themselves. Waves are a regular occurrence on the trading floor and they can lead you to bad decisions, regardless of whether they are driven by panic or avarice. Eventually, this can wreak havoc on your underlying investment strategy. If buying low and selling high sounds easy on paper, wait until you find yourself in the midst of an oncoming trend. The very thought of doing the opposite – of buying at the top and then selling at the bottom – is likely to cause a lot of stress, not to mention the monetary loss itself.
This is potentially the greatest disadvantage of herd mentality but serves well to point out the danger of pursuing a “buy low, sell high” strategy without putting much thought into it. The worst-case scenario is to overpay for stocks (if you allow bull market sentiment to cloud your judgment) or to buy low a stock that will tank even deeper (if you allow a bear market to do the same to you).
The case for the “buy low, sell high” strategy
There is a way to eliminate human emotions from the equation, at least to a degree. This is where it gets quite technocratic and analytical. While it is widely accepted that an investor can’t make a prediction regarding the fluctuation of stock prices based on historical data, many traders closely monitor trading volume and prices to identify trends. A big variety of technical indicators are used to “catch” such trends in the market as early as possible and in terms of “buy low, sell high”, moving averages are seen as an important indicator.
Obviously, you can find a lot of opinions on this subject, both for and against using moving averages as input in your decision-making process.
Crossing of moving averages
A moving average expresses the average price of a stock within a set period of time. Investors use the relation between two moving averages (the 50-day and the 200-day) to open or close a position. Let’s get more specific. If the 50-day moving average starts to cut across above the 200-day average, a buy signal is triggered and investors open a position. If it’s the other way around (if the 50-day moving average is below the 200-day moving average), a sell signal is triggered and investors close a position.
This strategy can definitely help restrain the effect of noise on investing decisions, but will it automatically translate into handing over the lowest and the highest point of any given trade to the investor? It’s hard to tell, but most probably not.
Alternative investing strategies
There are many different views about the optimal investing strategy. Some of them come close to “buy low and sell high” while others emphasize aspects that risk-averse investors would find accommodating. Let’s check out a number of alternative approaches which every investor can try.
Make small investments on a regular basis
This method is also known as drip-feeding (or dollar-cost averaging) and it embodies the principle of making small but consistent investments. So, when the prices are high, the investor will get fewer shares, but when the prices drop, they will get more shares by investing the same exact amount of money. If the markets are volatile, this helps limit potential losses. And when the prices go up, an investor can consider that the winning stock was bought at a bargain.
In a sense, this is a “buy low and sell high” approach – the key difference being the low volume of capital involved in the process.
Stay in it for the long haul
The temptation to lose track of long-term investment goals is real. Granted, it’s easy to get distracted by regular fluctuations in stock prices within a quarter or a year. However, if you take a step back to take in the long-term perspective, then it’s highly likely that prices will only grow over a period spanning decades.
So, if you are the investor that got those shares in order to hold onto them for as long as possible, you’ll only be able to cash in on your initial investment decades down the line. Of course, the challenge here is how to avoid liquidating your position after just a couple of years. After all, life happens, and investors might be forced to sell stocks due to adverse personal circumstances.
Engage in trading in the midst of an upward trend
It’s best if we start this one with a caveat: this is a strategy for day traders, not for investors. That is, while it can be hard to identify the extreme points (lowest and highest) of a given trend, it’s far easier to note that a trend has, indeed, emerged. In the case of an upward trend, a seasoned trader, who has spent some time studying historical data, is able to recognize if the herd instinct of the market will keep a particular wave going for some time.
The strategy is “buy high and sell even higher” – and the only risk is to experience a reversal of said trend before the day trader has liquidated all recently opened positions. The focus of this strategy are small, short-term gains, and this approach is not recommended for retail investors.
Diversify following the barbell strategy
Although at first glance it might seem like an advanced or unnecessarily complicated strategy, the barbell approach is a valid alternative. It’s simply not as prominent with beginner investors, as is the case with many other strategies by Taleb. The barbell strategy includes a mix of products (securities) with a varying degree of risk.
For example, an investor can put down a relatively small amount for volatile stocks instead of placing large amounts in low-risk products (like bonds). It’s an insurance policy of sorts – aimed at providing protection from the unlikely event of experiencing a grave impact. It combines the wealth preservation (conservative) and wealth creation (aggressive) aspects of investing and also allows incorporating both short-term and long-term investment goals.
Go for a mutual fund
If the risk of discovering the merit of investing strategies by placing your own earnings as collateral is too great for you as a retail investor, maybe you should abstain from buying and selling – regardless of whether prices are high or low. Going for an ETF, Index funds or Mutual funds will delegate both the anguish associated with your decision-making process and the responsibility for the eventual outcome to professional fund managers. This leads to a more balanced and diversified portfolio and it’s a legitimate way to invest, so many other investors do it.
Granted, you can’t match the potential gains from “buy low, sell high”, but at the same time, you get rid of the risks that come with it.
In closing
The “buy low and sell high” strategy might work for professional or experienced investors, but truth be told, guessing market extremes with an adequate level of certainty is near impossible. There are many examples of this, with the market crash in 2008 being the most recent. If an investor makes the right decision during such turmoil the returns are high. However, if the trend doesn’t reverse when it’s supposed to, the losses are substantial as well.
Efforts to time the market regularly prove futile, so those who don’t mind the risks involved can turn to a number of alternative investing strategies. Each approach has its passionate proponents, so there are a lot of options and lengthy discussions that back each of them up. Investors who don’t have much time to research individual stocks might fare best by investing in mutual funds. Every other investor can put the validity of their preferred approach to the test – with their own money.
