What is the “Buy Low, Sell High” Strategy?
It is preached about so often by investors that it’s almost become a cliche.
The mantra may sound a little too simple and obvious, and, sure enough, this investment strategy requires more strategizing than you’d expect.
The Buy Low & Sell High strategy is based on the nature of stock market cycles. In other words, it’s intended to help you capitalize on a fluctuating stock market.
The “Buy Low & Sell High” investment strategy is all about timing the market.
You buy stocks when they have hit a bottom price, and you sell stocks when the price peaks. That’s how you can generate the highest returns.
For example, if you buy a stock when the price is low —say, $50. And when the price peaks, you sell that stock for $100. You’ve just earned a 100% return on investment.
Stock market prices fluctuate for a variety of reasons, including:
- World events
- Corporate changes
- Overall economic health
- Herd Instinct
There’s a bit of psychology that goes into the stock market, particularly when it comes to “herd instinct,” when large groups of investors react in the same way to real or perceived risk factors.
For example, let’s assume a successful CEO announces he’ll leave the company at the end of the year. Because the company’s growth mostly occurred under his tenure, the investors believe that its profits will decline in his absence.
Many investors will begin selling stock in the company, which causes the stock price to fall.
Of course, just because the CEO is leaving doesn’t mean the company will fail. It’s possible that the CEO has developed a strong growth plan for the company by choosing a capable successor.
When you recognize that the company will probably be fine, and you jump on the opportunity to buy more shares at a low price, you will be profitable next year when the stock price rebounds.
Herd instinct is a powerful influence on short-term investors. But if you can mindful enough to avoid that instinct, you can potentially capitalize on those inevitable fluctuations in the market.
Buy Low, Sell High is a deceptively tricky stock investment strategy
You never know when a stock price is going to hit its highest or lowest point. If you try and determine the latest point to buy/sell, you will probably miss the window. It’s better to determine the earliest point you can buy/sell.
So how do you know when prices have dropped far enough to constitute a buy? And how do you know prices have risen enough to warrant a sell?
Investors commonly use two moving averages to help them decide whether a stock price is sufficiently low or high.
There are two different ways you can use these averages.
50-Day Moving Average: Tracks the short-term performance of a stock over the last 50 days.
200-Day Moving Average: Tracks the long-term performance of a stock over the previous 200 days.
Here’s the conventional approach taken by most investors:
Buy shares when the 50-day average rises above the 200-day average
Sell shares when the 50-day average falls below the 200-day average
If the 50-day average is higher than the 200-day average, it’s a signal that the stock price is rising significantly.
If you purchase the shares now, they’re probably going to grow in value.
The Converse Method
If you’re trying to maximize your returns, you could employ the reverse method:
Buy shares when the 50-day average falls below the 200-day average.
Sell shares when the 50-day average rises above the 200-day average.
The logic is that when stock prices are falling, you can buy a greater number of shares for a lower price.
If those stocks rebound, you can sell all those shares for a massive return on investment.
50-Day Moving Average: 100
200-Day Moving Average: 150
In this example, the 50-Day Moving Average has fallen beneath the 200-Day Moving Average, which signals a significant drop in value.
You jump on this opportunity to buy 10 shares (for $1000 instead of $1500—you save $500).
If the stock rebounds to $150, you could sell your 10 shares for $1500.
You will have profited (1500 – 1000) $500.
Not a bad return for a single company! String together a few similar investments, and you’ll have a significant passive income.
The big question, though, is whether or not the stock is going to rebound. If it does, then you can make a lot of money. If it doesn’t, you could lose money.
As a stock investor, the biggest challenge is determining the best time to buy low and sell high.
Market trends have proven on several occasions to be wrong — the right time to buy low and sell high must be determined by their own objective methods.
For example, in the late 1990s, the internet bubble was an excellent example. Investors were sure that internet stocks would continue to rise endlessly in 1999.
On the other hand, the market crash of 2008 influenced investors to think the housing industry would never recover.
Initially, sellers of internet stocks and buyers of housing stocks regretted their decisions during these periods of fluctuations.
However, they were proven wrong shortly as the trends began to move in the opposite direction.
The lesson: the best investors know that trends are only a piece of an ever-changing puzzle.
Sometimes it’s better to ignore the trend and follow their own methods when deciding to incorporate a buy low, sell high strategy.
Here are three main challenges with Buy Low, Sell High:
- Difficult to predict when to buy or sell, or when the stock prices will bottom out or peak.
- Difficult to predict whether a company will grow,
- And getting caught up in herd instinct.
The Importance of Stock Research
The numbers aren’t going to tell you the entire story about a company’s financial prospects. You must do your own research to better understand which direction a company is going.
Regardless of whether you buy stocks that are rising or falling in price, you want the company you’re buying shares in to maintain its growth.
Look into different facets of the company—financials, leadership, growth plan, and more. Read our guide on how to do stock research for a deep dive.
Conclusion: Buy Low & Sell High can generate high returns if successful, and may even outperform the market, but it is based on the principle of “timing the market.” — which is difficult to do, even for experienced investors.
You should do your own stock research to determine whether or not a company’s profits are likely to rebound.