Buy Low, Sell High Strategy: An Investor Guide
”Buy low, sell high” is an investor catchphrase, but can things really be that simple? In reality, this stock buying strategy may take more effort than you think. Read on to find out how it works!
What Is the “Buy Low, Sell High” Strategy?
As its name suggests, this strategy is all about market timing: You buy stocks at a low price, only to sell them when it hits a peak. This is how investors generate their highest returns.
For example, if you bought the stock at $50 per share, and waited until it reached $100, you would have made a 100% return on your investment.
This strategy is based on the nature of the stock market cycle, and capitalizes on the expected fluctuations in stock market prices.
Fluctuations can happen for the most unusual reasons and are influenced by world events. However, more predictable market changes boil down to economic health and corporate changes. These events may cause a company stock to both rise and fall.
The stock market relies on many mechanisms, one of which is hype, or “herd mentality.” This happens when large groups of investors react to a risk factor in the same way.
For example, a company CEO announced they would leave at the end of the following term. Most of the company’s growth had occurred during said CEO’s tenure. As a result, investors would predict a decline in the company’s profits after the CEO’s departure.
They then begin to sell the company’s stock, which causes the price to drop. However, since it’s impossible to be sure that the company would fail with a new CEO, this creates the opportunity for other investors to purchase stocks at a very low price.
The lack of investment in the company might ruin it, but if it manages to survive long enough to do well again, the price of its stocks will rise back up. Then, those who purchased the shares at rock bottom can resell them for far more than what they initially paid.
This is the meaning of “buy low, sell high” in its truest form.
How Do You Buy Low and Sell High?
Any investor can buy low and sell high, but it’s not a surefire way to profit. For one thing, you can never know when a stock price will be at its highest or lowest. If you try to wait until the very last minute to buy or sell, you may end up missing your window.
It is much safer to determine the earliest point where you can buy or sell and stick by that, even if the stock plummets or rises even further afterward. You’ll turn a smaller profit, but you’ll also avoid potentially disastrous turnarounds in price.
Investors use moving averages to figure out how a stock’s price is going. There are two relevant numbers here: The 50-day and the 200-day moving average. The approach most investors take is that they buy shares when the 50-day average moves ahead of the 200-day average.
If the 50-day average surpasses the 200-day one, that’s a signal the stock price is rising rapidly. If you buy shares now, they’re likely to grow quite a lot in value.
When the 50-day average moves back below the 200-day average, it’s a signal that the growth phase of a company is over. In other words, it’s time to sell your shares before they plummet in price again.
Buying Low and Selling High - Expected Challenges
Even though things may seem simple, the history of market trends tells us that, sometimes, looks can be deceiving. One important example is the dot-com bubble: Internet-based companies initially seemed like a brilliant opportunity for investors, and those who steered their trading based on this trend were sure of their future profits.
However, it led to an incredible increase in speculative trading, destabilizing the market and eventually causing it to crash in 2001.
The next, much bigger, crash happened in 2008 due to the deregulation of the financial market and banks engaging in securities trading. Many investors thought the market would never recover. Those who bought housing stocks regretted their decision, to say the least.
In other words, it takes a lot of knowledge to trade stock profitably and safely, even though more and more people are using modern solutions like online stock brokerages for their trading needs.
If you’re worried about not knowing enough to engage in trading on your own, you can always hire a professional stockbroker or look below for more information on determining how to buy low and sell high.
The Importance of Research
The isolated numbers you can find with a quick inquiry on a specific company will not give you a clear picture of its financial prospects.
In addition to its market performance, you’ll need to look into a given company’s various aspects, such as its leadership, growth plan, and performance history, especially in times of change.
In other words, if a stock you’re looking into is falling in price, that’s important information, but not enough to make a sound business decision.
You want to be sure the company you’re buying from will grow past its current stock-price hiccup. Otherwise, you might not come out on top when it’s time to sell.
Further Reading
The Cons of Buying Low and Selling High
While developing a buy low, sell high strategy sounds ideal, there are several snags you might hit:
Poor Predictions
If you don’t research the company whose stocks you’re buying well enough, you might end up with worthless stocks because the enterprise is beyond saving from the event that caused its stock price to fall.
Waiting Too Long
If you wait too long after the 50-day rises below the 200-day average to sell, you might miss the optimal point, and the price of your prospective stock might rise too quickly for the purchase to remain lucrative.
The same goes for waiting too long to sell - getting greedy and waiting for an even higher peak before selling has been the downfall of many investors.
Budget Mismanagement
This strategy is primarily based on the timing of the market, and those on a tight budget might not be able to afford to hold a stock as long as they need to for it to become profitable.
Some stocks need to be kept for years on end, and if you do not have enough money to survive in the meantime, this strategy can be hard to adopt fully.
Legal Issues
In most cases, buying low and selling high is completely legal. However, if you get some insider information about a company whose stocks you’re eyeing, you’re not allowed to act on it.
For example, if you know that the CEO of a company is quitting and someone more experienced is replacing them, it would be illegal for you to buy a lot of stocks prior to this event.
This is the most surefire way to buy low and sell high, but it’s also insider trading - a criminal offense punishable by up to 20 years in prison.
FAQ
Is “buy low, sell high” a good strategy?
So, is buying low and selling high a good strategy? Even though it seems like common sense, this may not be suitable for every investor. For this to be profitable, you need to have a good grasp of market trends, enough funds to be able to purchase stocks and hold them until they start performing well enough to sell, and know when to sell, without getting too greedy.
Is it illegal to buy low and sell high?
In general, this trading strategy is entirely legal. However, you will have trouble with the law if you decide to act on information about stocks that you have obtained through non-public channels, i.e., confidential information about a company whose stock is being traded. This constitutes insider trading, which is illegal.
Why do you buy high and sell low?
The opposite strategy to the one discussed in this article, is to buy high and sell low. However, this way of trading doesn’t apply to every stock. Instead, the general idea here is for you to buy the best stocks, as measured by their performance in the market.
If you purchase strong stocks, you can hold them while they gain value, and sell once their performance starts deteriorating. This technique is based on so-called “relative strength,” i.e., a stock’s strength relative to the market.
Is it better to hold, or sell and buy lower?
The answer to this really does depend on too many factors for just one solution to apply to every situation. Your financial situation, how quickly you need to make a return, and more, will determine the best course of action. However, you can always hire a financial advisor to help you make these difficult decisions.
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