

The Paradox of “Buy Low, Sell High”

This article was written by in Investing. 12 comments.

If everyone could “buy low and sell high” when making investment decisions, everyone would be a successful investor. I would never give this advice to anyone. First, it is obvious to anyone who understands basic arithmetic. If you want to make money, you have to sell something for more than you paid for it. This is why people are reluctant to sell houses right now. Buyers are waiting for lower prices because they think the market will continue to go down for some time and sellers — unless they are highly motivated — don’t want to sell until prices go back up.

Second, it is impossible advice to follow. Unless you have inside information on a specific company — and that is very unlikely — you don’t know with certainty whether a stock price is going to up or down over the next month, year, or decade. The price set by the market, with so many buyers and sellers, is generally the accurate price for that stock at that time. The only way to know whether a price was a “low” or a “high” is to look at the numbers well after the fact.

On Friday, the S&P 500 index hit a low point not seen since the mid 1990s. But will future investors look at Friday’s price as a low? It depends on where the stock market goes from here. Many experts predict that the bottom has not yet arrived. Friday’s low might be high compared to what the future may hold if stocks retreat to levels not seen since the 1980s.

In reality, people don’t buy low and sell high. Yes, there is the argument that people follow trends (rather than lead trends), often resulting in buying high and selling low. But more importantly, investors buy when they have cash and sell when they need cash. As it happens, on average, people have cash when the economy is good and need cash when the economy falls. Stocks are often a victim of this same economy. The stock market generally follows the sentiment of the greater economy, so your cash moves into stocks when they are high and moves out back to cash when stocks are low.

This phenomenon is a result of looking at averages; on an individual level, anything can happen. You could be flush with cash while the rest of the economy suffers and more people are out of work, or you could be struggling while everyone else flourishes. On average, economic conditions force investors to buy high and sell low.

One way to turn this around for your own benefit is to try to understand what most people are doing, and do the opposite. If you buy stocks while there is a general tendency among the rest of the market to panic and sell stocks, you have a better chance of buying at a low point. If investing becomes the latest craze and you can’t go anywhere without having stock tips thrown at you, the exuberance could be irrational and you have a better chance of selling at a high point.

Rather than advising someone to “buy low and sell high,” a strategy which would involve knowledge of the future, perhaps it would make more sense to advise to “buy during panics and sell during exuberance.”


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{ 6 comments… read them below or add one }

avatar Smithee ♦1,358 (Quarter)

So I should put everything into Citigroup, yes? :)

Seriously, though, thanks for reframing the argument. I’d been thinking it was completely irrational for people to keep selling after the Dow had gone down 4,000 points.

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avatar The Weakonomist

If you don’t like buy low/sell high, how about: “run into the burning building as everyone else is running out”

The idea assumes everyone follow trends and loses money. So when people are pulling out of the market it is time to buy. When people are jumping back in it is time to sell.

On a side note, anyone interested in buying a house that is waiting for prices to go lower is an absolute idiot. If you wait you will miss the bottom, I promise you that.

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avatar p

It’s interesting how simply you can state those big ideas.

I personally like the advice buy low and sell high but find it far from simple. Does low price mean price per share, total market cap, position relative to peers, price to earnings or book or sales or earning growth? What about bond yield, rating, maturity? Those last sentences are a better reason to hold that advice to yourself, you have to advise a lot more research and planning along with it. It’s no fun to assign work.

I also question the assumption that the market price is generally accurate at ‘that time’. Were the big financial companies situations really good investments a year ago? Were the big Ponzi schemes good investments 4 months ago? The market tries to be efficient but is still based on perceptions, forecasts, and greed. I agree that if you know the future you know the answer, but I don’t agree that if you don’t know anything you should trust the market or assume that it knows.

As far as panics and exuberance go, how can you point these out without knowing if it is low or high? Should I sell all the nanotech, clean energy, solar, biofuels, genetic investments I have if they actually start catching on, is that exuberance? Should I avoid the next Microsoft or Google type IPO if there is any hype around it, too much exuberance?

I believe the real issue is to avoid ignorant decisions. The only way to do that is to know what you are doing. Don’t try to buy low if you are ignorant of what low means. Don’t trust the market if you don’t know how it works. Follow those other little pieces of advice that pop up from time to time… Invest in what you know, build your knowledge, make a plan, and put time and effort in before money.

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avatar thomas

Hmm, interesting.

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avatar Manshu

This is the funniest dissection of this idea that I have seen. It is all fluff and no real concrete idea.

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avatar RAJESH

only one wayto make money is buy low sell high / others ways are all rubbish / now you are scared as still it will go lower / so you start gradually buying / lets say u gonna buy 200 shares of xyz.

well buy 1 share everyday for the next 200 days / you will not miss the bottom

else adopt varied methods / alternate day buying / weekly buying / this removes the fear in you

the lower it goes / great / you will make more money

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