When it comes to investing, there are certain rules of thumb that investors are often encouraged to follow. One of the most-repeated adages in investing is to “buy low sell high”.
Buying low and selling high simply means purchasing securities at one price, then selling them later at a higher price. This bit of investing wisdom offers a relatively straightforward take on how to realize profits in the market, but implementing it is more complicated than it sounds.
Figuring out how to buy low and sell high–and make this strategy work–is a bit more complicated, however. Timing the market is not a perfect science and understanding that is critical to investor success.
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What Does It Mean to “Buy Low, Sell High”?
“Buy low, sell high” is an investment philosophy that advocates buying stocks or other securities at a lower price than you can later sell them. This is the opposite of buy high sell low, which effectively results in investors selling stocks at a loss.
When investors buy low and sell high they may do so in an attempt to maximize profits. For example, a day trader may purchase shares of XYZ stock at $10 in the morning, then turn around and sell them for $30 a share in the afternoon if the stock’s price increases. The end result is a $20 profit per share, less any trading fees or commissions.
Likewise, a buy-and-hold investor may purchase stocks or mutual funds and hold onto them for years or even decades. The pay off comes if they sell those securities later for more than what they paid for them.
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3 Tips on How to Buy Low and Sell High
Understanding stock market cycles and their correlation to the business cycle can help when determining how to buy low and sell high. If the business cycle is an expansion phase and the economy is growing, for instance, then stock prices may be on the upswing as well. On the other hand, if it’s become apparent that economic growth has peaked, that could be a signal for stock price drops to come.
It’s also important to remember that security prices typically don’t move in a straight line up or down. Most securities instead experience at least some level of volatility, where their prices move up or down (or both) in the short term before reverting to the mean.
These tips can help when developing a buy low, sell high strategy (or to simply avoid the buy high, sell low trap).
1. Look at Stock Pricing Trends
Investors who want to buy low may find it helpful to pay attention to pricing trends. Tracking trends for individual securities, for a particular stock market sector, or for the market as a whole can help investors get a sense of what kind of momentum is driving prices.
For instance, an investor who’s wondering how low a stock price can go can look at trends to identify significant pricing dips or rises in the stock’s history. This can make it easier to determine when a stock or security has reached its bottom, opening the door for buying opportunities. Conversely, investors can also use trends to evaluate when a stock has likely reached its high point, indicating that it’s prime time to sell.
2. Use Moving Averages
Moving averages are a commonly used indicator for technical analysis. A moving average represents the average price of a security over a set time period. So to find a simple moving average, for example, an investor would choose a time period to measure. Then they’d add up the stock’s closing price each day for that time period and divide it by the number of days.
The moving average formula can be useful for comparing stock pricing and determining points of resistance. In other words, they can tell investors where stock prices have topped out or bottomed out over time. Moving averages can smooth out occasional pricing blips that push stock prices up or down temporarily.
Comparing one moving average to another, such as the 50-day moving average to the 200-day moving average, can also help investors to spot sustainable up or down pricing trends. All of this can help when deciding when to buy low, sell high.
3. Beware of Investor Bias
An investor bias is a pattern of behavior that influences reactions to a changing market. For example, noise trading happens when an investor makes a trade without taking the state of the market or timing into account. The investor may be following pricing trends but making trades without considering whether the time is right to buy or sell.
Investors who give in to biases may find themselves following a herd mentality when it comes to making trades. If news of a pending interest rate hike sparks fear in the markets, for example, investors may start panic selling in droves. This can in turn cause stock prices to drop. On the other hand, irrational exuberance for a specific stock or type of security can push prices up, causing an unsustainable market bubble.
Investors who can refrain from being influenced by the crowd stand a better chance of making rational decisions about when to buy or when to sell to either maximize profits or minimize losses.
Pros and Cons of Buy Low, Sell High
A buy low, sell high strategy can work for investors, but while it’s a worthy goal, the implementation can be difficult. Investors who are too focused on timing the market can run into difficulties.
Benefits of Buy Low, Sell High
Buying low and selling high can yield these advantages to investors.
• Bargain-buying opportunities. If investor sentiment is causing fear and panic to take over the market and push stock prices down, that could open a door for buy low, sell high investors. Individuals who choose to ignore market panic could purchase stocks and other securities at a discount, only to benefit later once the market rebounds and prices begin to rise again.
• Potential for high returns. An investor who is skilled at spotting trendings and reading the market cycle could reap sizable profits using a buy low, sell high strategy. The wider the gap between a stock’s purchase price and its sale price, the higher the profit margin.
• Beat the market. A buy low, sell high approach could also help investors to beat the market if their portfolio performs better than expected. This might be preferable for active traders who choose to forgo a passive or indexing approach to investing.
Disadvantages of Buy Low, Sell High
Attempting to buy low and sell high also holds some risks for investors.
• Timing the market is imperfect. There’s no way to time the market and which way stock prices will go at any given moment with 100% accuracy. So there’s still some risk involved for investors who jump the gun on when to buy or sell if stocks haven’t reached their respective lowest or highest points.
• Being left out of the market. Investors who want to buy low and sell high would not want to buy securities when the market is up. That practice, however, could lead to substantial time out of the market entirely.
• Biases can influence decision-making. Investment biases and herd mentality can wreak havoc in a portfolio if an investor allows it. Instead of buying low and selling at a profit later, investors may find themselves in a buy high, sell low cycle where they’re losing money on investments.
• Pricing doesn’t tell the whole story. While tracking stock pricing trends and moving averages can be useful, they don’t offer a complete picture of what drives pricing changes. For that reason, it’s important for investors to also consider other factors, such as consumer sentiment, the possibility of a merger or geopolitical events, that could be influencing stock prices.
Alternatives to Buy Low, Sell High
Buying low and selling high is not a foolproof way to match the market’s performance or beat it. It’s easy to make mistakes and lose money when attempting to time the market, unless of course, you possess a crystal ball or psychic abilities.
There are, however, other ways to invest successfully without trying to get market timing right. Take dollar-cost averaging, for example. This strategy involves staying invested in the market continuously through its changing cycles. Instead of trying to time when to buy or sell, investors continue making new investments. Over time, the highs and lows in stock pricing average out.
A dividend reinvestment plan or DRIP is another option. Investors who own dividend-paying stocks may have the option to enroll in a DRIP. Instead of receiving dividend payouts as cash, they’re reinvesting into additional shares of the same stock. Similar to dollar-cost averaging, this approach could make it easier to ride out the ups and downs of the market over time and eliminate the stress of deciding when to buy or sell.
While buying high and selling low is a good strategy in theory, it can be difficult to implement in practice. Executing a buy low, sell high strategy successfully means doing some research and due diligence to understand how the market works.
For investors who prefer to be more hands-off, automated investing could be the smarter approach. One way to get started is by opening an account on the SoFi Invest brokerage platform, which allows you to build wealth automatically with competitive fees.
Photo credit: iStock/katleho Seisa
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