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 figuring out how to buy low and sell high — and make this strategy work — is a bit more complicated. Timing the market is not a perfect science, and understanding that implementing a buy low, sell high strategy is more complicated than it sounds is critical to investor success.
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 buying high and selling low, which effectively results in investors selling stocks at a loss.
When investors buy low and sell high, they may do so 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 per share in the afternoon if the stock’s price increases. The result is a $20 profit per share, less trading fees or commissions.
Likewise, a buy and hold investor may purchase stocks, exchange-traded funds (ETFs), or mutual funds and hold onto them for years or even decades. The payoff comes if they sell those securities later for more than what they paid for them.
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4 Tips on How to Buy Low and Sell High
The following tips may help investors develop a buy low, sell high strategy (or avoid the buy high, sell low trap).
1. Investing with the Business Cycle
Understanding stock market cycles and their correlation to the business cycle can help when determining how to buy low and sell high.
The business cycle is the rise and fall in economic activity that an economy experiences over time. If the business cycle is in 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 as an economy slows or enters into a recession.
But like most strategies that aim to buy low and sell high, investing with the business cycle can be challenging.
It’s also important to remember that security prices typically don’t move in a straight line up or down in lockstep with a specific phase of the business cycle. Instead, most securities experience a level of volatility, where prices move up or down (or both) in the short term before reverting to the mean.
2. Look at Stock Pricing Trends
Investors who want to buy low may find it helpful to pay attention to pricing trends or technical indicators. Tracking trends for individual securities, for a particular stock market sector, or the market as a whole can help investors get a sense of what kind of momentum is driving prices.
For instance, an investor wondering how low a stock price can go can look at technical indicator 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.
3. 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 help compare stock pricing and determine 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 temporarily push stock prices up or down.
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 this can help when deciding when to buy low or sell high.
4. 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 considering the state of the market or timing. The investor may follow pricing trends but make 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, 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 stock 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 as they buy the dip. Individuals who 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 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 and 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 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 for investors who jump the gun on when to buy or sell if stocks have yet to reach 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, especially during bull markets.
• 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 lose 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 also to consider other factors, such as consumer sentiment, the possibility of a merger, or geopolitical events, influencing stock prices.
Alternatives to Buy Low, Sell High
Buying low and selling high is not a foolproof way to match or beat the market’s performance. 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 (DRIP) is another option. Investors who own dividend-paying stocks may have the opportunity 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.
Investing with SoFi
While buying high and selling low may be a good investment strategy, it can be challenging to implement. Executing a buy low, sell high plan successfully means researching and doing due diligence to understand how the market works.
For investors who prefer a more hands-off investing approach, automated investing may be a better option. One way to get started is by opening an online brokerage account with SoFi Invest®. With SoFi automated investing, you can build wealth automatically with competitive fees.
Is buying low and selling high a good strategy?
Buying low and selling high is generally a good strategy as it allows you to take advantage of price movements in the market. However, there is no guarantee that this strategy will always be successful, and you may end up losing money if the market conditions are not favorable.
Is it illegal to buy low and sell high?
There is no law against buying low and selling high. Most investors make money by buying a security at a low price and then selling it later at a higher price.
Why do you sell high and buy low?
Many investors sell high and buy low because they want to take advantage of market conditions to realize a positive return. When the market is high, investors may sell an investment they purchased at a lower price to make a profit.
Photo credit: iStock/katleho Seisa
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