Veneta Lusk is a family finance expert and journalist. After becoming debt free, she made it her mission to empower people to get smart about their finances. Her writing and financial expertise have been featured in MSN Money, Debt.com, Yahoo! Finance, Go Banking Rates and The Penny Hoarder. She holds a degree in journalism from the University of North Carolina - Chapel Hill.
One of the most common pieces of advice when it comes to investing is to “Buy low, sell high.” It is touted as one of the keys to being a successful investor.
The idea seems simple, but it may be more complicated than it seems.
What buy low, sell high means
The idea behind “buy low, sell high” relates the nature of stock market cycles. Stock prices fluctuate based on many factors: world events, the Treasury interest rate, a company’s growth earnings, the perceived risk of a stock, inflation, the economic strength of the market, and so on.
The price of a stock at any given time is based on the supply and demand at that moment in the market. As the equation changes so does the stock price.
The strategy behind buying low and selling high relys on trying to time the market. Buying low means trying to determine when stocks have hit bottom price and purchasing shares in the hope of them going up. Conversely, selling high relies on figuring out when the market has hit its peak. Once stocks have hit their maximum value, investors sell their shares and reap the rewards.
How to follow a buy low, sell high strategy
Investors who look to buy low and sell high look at several factors to determine if the price of a stock is within the right range. It can be challenging to implement this strategy consistently, so traders look for certain markers to make an informed decision.
Those looking to buy low follow the price fluctuations of certain stocks, sectors, or the entire market. It is important to look at stock prices over time to account for any short-lived price drops or bumps. This shows the general direction of stocks over time.
Looking at historical prices for a stock and current market conditions, investors try to determine when shares have gone low enough to constitute a buy signal. This can be an individual company’s stock, an exchange traded fund (ETF) following a particular sector, or a total market index fund.
On the other end, investors who want to maximize earnings look for indications that stock prices have gone up high enough. Once the value has gone high enough to constitute a sell signal, traders sell the stocks and pocket the difference.
Seasoned investors rely on moving averages to determine the best time to buy or sell a stock. This metric shows how a stock’s price has performed over time.
For example, looking at the 50-day moving average gives traders an idea of how the stock’s performance over a relatively short period. On the other hand, the 200-day moving average shows how it’s doing over the long term.
When the 200-day moving average crosses the 50-day moving average, it shows it’s a good time to sell. When the averages cross the other way, investors often consider selling.
Advantages and limitations of buy low, sell high
There are both advantages and disadvantages to following this strategy.
Advantages of buy low, sell high
During a bear market, stock prices go down and investors tend to sell off shares as fear takes over. This is the time to buy at a discount as long as you have the capital and the knowledge to evaluate the best stocks to purchase.
As the economy recovers, stock prices go up, increasing the value of the shares bought when the market was low. Greed takes over, pushing the stock prices up as the economy enters a bull market.
Times of maximum greed are the best time to sell stocks. While those are clear when looking back, this is not an easy metric to pinpoint.
Limitations of buy low, sell high
There are many limitations to the “buy low, sell high” strategy. While it looks like a good idea on paper, it’s essentially a way to time the market.
But trying to figure out the best time to buy and sell a stock is generally considered a bad idea for the average investors since there are many factors that play into stock prices, and markets are, by their nature, unpredictable,.
While hindsight is 20/20, it is difficult to pinpoint the best time to buy or sell a stock. Most investors are fearful when stock prices plunge and sell, even if it means taking a loss.
On the other hand, when market prices are soaring, many traders want a piece of the pie and end up overpaying for stocks. Human emotions make it difficult to execute a strategy that goes against investor sentiment.
If you go solely by the price of a stock, buying low can be a bad idea. A company’s shares can drop in value for many reasons.
Before determining if you should buy a particular company’s stock, it’s important to do your research. You need to identify why the stock price is so low and determine if it can recover down the road.
In addition, the tax implications of the buy low, sell high strategy can make this a pricey mistake for inexperienced investors. It’s best to leave this strategy to seasoned traders who understand the stock market.
Alternatives to the buy low, sell high strategy
Many investors who try to buy low and sell high end up making costly mistakes. Rather than trying to time the market, there are better alternatives for investing your hard-earned dollars.
Instead of individual stocks, consider investing in ETFs and index funds following a particular sector or type of company. A well-diversified low-fee portfolio with a such as Wealthsimple Invest can take the guesswork out of investing.
If you decide to invest in individual stocks, research each company well, looking at their financial reports and get a feel for the stock’s performance over time. Most companies have these reports on their websites.
If you can’t find them there, check out EDGAR, which is the filing database for the U.S. Securities and Exchange Commission (SEC). For reports and documents filed with the Canadian Securities Administration, check the SEDAR database.
The bottom line
While the common investment advice to buy low and sell high may seem like a simple idea, it’s not a good option for the average investor. This strategy tries to time the market and determine the best time to buy and sell a stock. However, if you only follow the price of a stock and don’t do additional research, you are bound to make a costly mistake. In addition, it’s difficult to be rational when others are panicking.
Only the most seasoned investors can ignore public sentiment and buy when stock prices are plummeting and sell when they are soaring. You need to understand why a company’s stock is going up or down to determine if it’s time to buy or sell, and that kind of comprehension is difficult even for professional investors.
Most investors would do best with a diversified portfolio of stocks and bonds tailored to their risk tolerance.
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