What Is Buy Low, Sell High?
Buy low, sell high sounds like good advice. But, it turns out it is almost impossible to implement consistently over time. History demonstrates time and again that the markets tend to overshoot on both the downside and the upside. Part of the reason is a herd instinct that drives stock prices. An extremely savvy investor might be able to see the herd instinct at work and take advantage of extreme ups or downs. Sometimes, an investor can buy low and sell high. Unfortunately, it can only be determined after the fact whether a price was low or high. During the moment, it is difficult, if not impossible. Prices not only reflect market fundamentals but both the psychology and emotions of market participants.
For this reason, buy low, sell high can be challenging to implement consistently. Traders trying for a more objective view consider other factors to make a more informed decision. These factors include moving averages, the business cycle, and consumer sentiment. (Source: investopedia.com)
How to Spot Buy Low, Sell High Opportunities
The idea behind buy low, sell high relates the nature of stock market cycles. Stock prices fluctuate based on many factors. These include 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 in the market at that particular moment. As the influencing factors change so will the stock price.
The strategy behind buying low and selling high relies on trying to time the market. Buying low means trying to determine when stocks have hit their 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 hoping to reap the rewards with the maximum possible gains.
Moving averages are determined solely from price history. They show price fluctuations over time. They essentially smooth out the short-lived price bumps to show the general direction of a stock over time. Some traders track two moving averages, one of short duration and another with a longer duration, to protect downside risk. One common method is to use the 50-day and 200-day moving averages. When the 50-day moving average crosses the 200-day moving average, it generates a buy signal. When it crosses the other way, it generates a sell signal. The point of the moving average is to help a trader time a buy or sell at the right point in the trend.
Business Cycle and Sentiment
Over the long term, the drivers of the market as a whole follow a consistent pattern. They move from fear to greed and back to fear. During maximum fear is the best time to buy stocks, at a bottom or low. During maximum greed, on the other hand, is the best time to sell at a high. These extremes take place a couple of times every decade and have remarkable similarities. The emotional cycle follows the business cycle. When the economy is in a recession, fear predominates. This is the time to buy low. When the economy booms, prices go up, and this is the time to sell. Long-term investors might consider watching the business cycle and consumer sentiment surveys as market timing tools. Regularly published reports can provide further insight into the business cycle.
There are notorious examples of market extremes. This includes the internet bubble of the late 1990s and the market crash of 2008. Both proved to be excellent opportunities for those who bought low and sold high. At the time, it seemed as if the trend would never end. It was commonly believed internet stocks surely would never go down in 1999. It was also believed the housing industry certainly would never recover after 2008. In those moments, investors who sold internet stocks or bought housing stocks might well have felt they were being punished. The trends kept going in the other direction—until, that is, they didn’t. A successful investor must ignore the trends and stick to an objective method of determining whether it’s time to buy or time to sell. (Source: investopedia.com)
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 indicators 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. (Source: wealthsimple.com)
Advantages and limitations of Buy Low, Sell High
There are both advantages and disadvantages of 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.
- During maximum greed is 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 an attempt 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. There are many factors that play into stock prices, and markets are, by their nature, unpredictable.
- Difficult to pinpoint – 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.
- Investor exuberance can cause price bubbles – When market prices are soaring, many traders want to jump in and end up overpaying for stocks. Human emotions make it difficult to execute a strategy that goes against investor sentiment.
- Don’t ignore fundamentals – 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.
- Do your research – 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.
- Don’t forget tax implications – In addition, the tax implications of the buy low, sell high strategy can make this a pricey mistake for inexperienced investors.
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.
- Consider ETFs – 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 can take the guesswork out of investing.
- Consider fundamentals, not just price – 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.
- Government Reports are a great resource – 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.
Understand Your Risk Tolerance
So what can you do to avoid the pitfalls of trying to buy low and sell high?
- Understand your goals and risk tolerance: before you get started investing, it is critically important to understand what it is you are trying to accomplish and how much risk you are comfortable taking. Once you have that figured out, you can create an investment plan that is appropriate for you and comfortable enough to keep you from impulse buying high and panic selling low.
- Avoid market timing: instead of trying to time investments perfectly and squeeze every last cent out of each one, focus on building a diversified portfolio of stocks and bonds that give you the greatest chance to succeed over the long term.
- Leverage your resources: having a great financial plan and a diversified portfolio is irrelevant if you don’t follow through and stick to it. Becoming self-aware of the pitfalls is a great first step. Having a good financial advisor is a good step too. Just make sure that they are a fee-only fiduciary, so that they have your best interests in mind at all times. (Source: shermanwealth.com)
Why is it So Hard to Buy Low, Sell High?
Buying low comes from an investment philosophy known as value investing. The basic concept of value investing is to buy investment instruments when they are “on sale.” That means buying when everyone else is selling (and prices are down) and vice versa. A bargain-hunting value investor looks for what they consider to be healthy companies that are – for whatever reason – severely undervalued. A smart value investor buys low, then patiently waits for the “herd” to catch up. Unfortunately, most investors tend to do the exact opposite. Human nature tends to chase trends and follow the herd.
You may want to buy low and sell high, but that goes against natural human tendencies. When a stock is falling, you dump it. When a stock is rising, you buy it. Investors sell a company when the price is falling because they are afraid of losing more money. They buy a stock when it is rising because there is a fear of missing out. Also, most investors do not do the necessary research. Therefore, they are not experts at realizing when something high or low “enough.”
Buy Low Sell High – The Bottom Line
The common investment advice to buy low and sell high seems like a simple idea. However, it’s not a good option for the average investor. This strategy tries to time the market. The goal is to try to predict the best time to buy and sell a stock. 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 calm and 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.
if it were easy – if everyone bought low and sold high – there would be no high or low. This is because the market prices would be continually correcting. However, bargains do exist and sometimes the wisest choice is to lock in earnings. The safest financial plan for the long run, however, is to understand your goals and risk tolerance. Then work to create an investment plan that builds on gains over the long term, rather than continually outguess the market.
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