The great investing myth (1): Buy low, sell high 📈

Photo by Steven Cordes on Unsplash

Everyone knows “buy low, sell high”.

The low is often not obvious at the moment but in hindsight.
Many wait with a huge pile of cash for a crisis to crash the market to buy low; the lowest possible. They look for the low and when it will be reached. There are several psychologies and emotions that we should be aware of and the corresponding ironies created:

  1. Often, our conviction is based on the belief that the assets will go up (conviction with an anchoring bias). We actually become more fearful that we sell at the low as well as tune out of the market and miss the low. The lower the market goes, the more our conviction is shaken and dissipates, and our fears increase. Any positive news at the depth of the crash is not good enough to push through our walls of worry.
  2. Bottom = low. People associate the bottom with the low. Without knowing the low, many will not want to catch the low as it can go lower.
  3. We know the low after we pass it; in hindsight. We will not know the low at that moment; whether it will go lower or higher. We only know the low is reached after we go higher from it.
  4. However, how much should the market go up from the low to confirm that the low has been established? Market bottoming are often not obvious. Some are still gripped with fear that they are lost and confused. Some may think it is a relief rally, a fake rally, or a bear’s trap. Things in the real economy are still not looking good. Many do not believe we have passed the bottom. There is no consensus even among the experts during such periods. There have many different and opposing views which can result in volatile market movements (some buying, some selling and shorting).
    Market turns requires a change of views and sentiments of the market. The stronger views (or having no views and relying on other gurus for cues and references), the more difficult will be to change one’s views. The market turns represent a change of sentiment from being fearful to less fearful.
  5. We can create a circular reference ourselves. Sometimes, by the time we change our views about the market directions, we feel that the market has gone up so high (measuring the percentage gain from the low) that we felt the “buy low” opportunity is over. 🤦‍♂️🤦
  6. What if the market goes lower than our expected low? When the low we believe turns out wrong and our positions may go into more losses, we may agonise over our misjudgement and may be gripped with more fear that we may not buy anything lower.
  7. Depending on the severity of the crash, many may become more pessimistic and fearful that they keep lowering their expected low. What if the market does not hit our expected low and rebounds? Do we continue to believe strongly that we are right and insist that the market will collapse to our targeted low? What if we are wrong? Will we change and adjust our views or we remain insistent on our views that we did not buy anything?
  8. It may not be the rally we expect after reaching the low. It may not be the sharp V-shaped rally that some expect. It can stay low for some time. The market reaches a low as the worse has been discounted. How the market will recover is dependent on the positive catalysts and the change in sentiments. It can be U-shaped, L-shaped or K-shaped where selected stocks rally and others remain sluggish

If you weren’t scared, you weren’t paying attention.

Warren Buffett on financial crisis

To follow the good [trading] principles and not let fear, greed, and hope interfere with your trading is tough. You are swimming upstream against human nature.

Richard Dennis

To get excited and buy low when the market crashes is difficult. Courage and rationality are needed.

The above is my observation of how many retail investors behave. Many may end up not buying in the down cycle. It is difficult to call the bottom, catch the lows or near lows.

The high is not obvious too but in hindsight.
Similarly, people want to sell as high as possible.

  1. The higher it goes, the more we are so confident in our conviction. We are right! We are genius. Mixed with greed and over-confidence, we may just ignore the target price. We just want the market to go higher and higher (to the moon) that we just hold.
  2. High = peak.
  3. We only know the high after we pass the high.
  4. How much should the market plunge from the high to determine that the peak has been established?
  5. Circular reference sets in when the markets have plunged so much from the peak that we feel we miss the high and gone so low that we decide not to sell.
  6. What if the market goes above our expected high? Do we sell higher?
  7. What if the market does not hit our high and goes lower?
  8. As the market falls from the high, it may not crash as we expect.

Let’s analyse this further.

“Buy low, sell high” is common sense. Have a plan.

It is analogous to telling companies to sell higher than the cost price as a strategy; this is common sense and not useful as a strategy. Many tend to mistake buying low and selling high as a strategy. Yes, buying low, and selling high is the way to profit. It is not useful and specific enough to guide us to decide on the following (which an investing strategy should):

1. What to buy?
2. What price to buy?
3. How much to buy?
4. What to sell?
5. What price to sell?
6. How much to sell?

We need a strategy to guide us with rationality and objectivity during periods when we can get fearful of buying low and greedy to sell high.

Everyone has different lows and highs.

Investing/trading strategy is personal and can be very different. Everyone has a different “buy low, sell high” based on the type of stocks they select (speculative, hot/hyped, value, income, growth, blue chips etc), time horizon and risk preferences.

For details: Everyone needs to have their own investment strategy to succeed.

For traders, the lows and highs can be a few percentages within short time frames (lows and highs within the day, days, and weeks). Long-term investors look at the lows and highs over longer time frames (months and years); going for much more percentage gains. The very long-term investors may just hold and ride with the companies’ growth and sell less.

Hence, with this context, we can understand the different views and nuances analysts, market commentators, social media and friends have on the markets.

Credit: Brian Feroldi

Lows and highs are relative terms.

We will not know the low at that moment; we only know the low in hindsight. We only know the low after we pass it and go higher. We will not know whether buying 30% or 50% lower from the recent local top is considered low. The lows will become more distinctive and confirmed after a few weeks/months when the current price is way higher than the lows. The same applies to the highs, especially with poor-quality companies riding on speculation and momentum.

Timing the market in different time horizons

The shorter the time horizon, the more “buy low, sell high” is about timing the market. Regardless of the time horizon, stocks go low and high because of fear and greed sentiment which differ in their magnitude.

Different time horizons and strategies require different skills, experience and temperaments to time the market to buy low. A shorter time horizon strategy will have more “buy low, sell high” possibilities than longer-term investors. The latter tend to prefer time in the market to timing the market. However, the difference is a function of strategies which result in different “buy and sell” churns.

Quality of assets matters > low absolute price

Not all stocks (companies) are the same. Buying stocks at low prices does not guarantee that they will go up. Their quality and valuation matter much more.

As stocks drop, we need to know which stocks are worth buying. If there is a major crisis in the operating environment, it may be unfavourable to some sectors and companies. Some who are less competitive can have problems surviving. Buying low on these companies can be akin to catching the falling knife. On the other hand, high-quality companies improve and thrive with crises; these are the ones to bottom fish. We need to know which companies to buy low. Do not buy just because a stock falls a lot more than others even if it has a “good” name; do investigate the causes and evaluate based on your due diligence. Some will choose to buy the index or sector ETFs instead of individual stocks as they find it difficult to follow the development of the situation and identify the resilient companies among all.

Give me a turbulent world as opposed to a quiet world and I’ll take the turbulent one. Bad companies are destroyed by crisis, Good companies survive them, great companies are improved by them.

Andy Grove

Our conviction matters to buy low and sell high.

A strong conviction with a strong investing thesis is required to counteract fear and greed and keep our emotions steady. When the market pulls back with a fearful sentiment, the conviction becomes more crucial as to what stocks are to sell, hold and add. When the market surges, valuation is high and everyone is greedy, we need the conviction to sell. Without knowing what to look for as the markets move up and down, it is difficult to know what is low to buy and high to sell.

Many are often more emotional than rational when the market is at a low and high.

When the market falls and crashes, many investors and traders may actually be rooted in fear and uncertainty that they did not buy low and sell high. As the market falls, they are more anxious and fearful the market may go lower and lower. The same applies to market highs. Many feel invincible and complacent with the market high and keep hoping it will go higher and higher than sell high.

We should have a good plan to guide us in periods of crashes and exuberances where we can manage our emotions and maintain our rationalities to buy low, and sell high.

Some just buy and keep holding; staying invested (time in the market).

Some buy and do not sell. Some are very long-term investors like Warren Buffett, Motley Fool, and Wilmot Kidd who hold stocks for decades with huge unrealised returns (easily between 10 to 100 times returns). It is easier to buy and hold high-quality companies through market drops to sell high and buy low. Unfortunately, many retail investors tend to hold to losing stocks. This is the topic of the next investing myth: The great investing myth (2): Buy and hold.

“The big money is not in the buying or the selling, but in the waiting.”

Charlie Munger

Buy low, trim high (timing the market)

When we managed to catch some very high-quality companies that we have been buying low, we may just trim some as it goes higher. As mentioned previously, we do not know their true potential well and the high can keep going higher. So instead of selling high as in selling everything, trim to keep some to sell higher as it keeps unleashing its potential.

Catching the relative lows and highs (1): Dollar-cost average (DCA)

Instead of timing the absolute low to buy, a better way to catch the low will be the dollar-cost average (DCA). It is one approach to buying the relative (not the absolute) low in a more disciplined, less emotional approach. It can be done in several ways such as:

  1. Invest a fixed capital within every predefined period; buy $x every month
  2. Invest a fixed capital with every % or dollar drop in the market; buy $x whenever the share price drops x% or $x
  3. Invest a fixed capital whenever the price reaches a technical support level; for example: buy $x (or DCA for a period) when the weekly RSI reaches 20 which has been its lowest before it rebounds

The above can be flipped and used for selling into the highs.

Catching the relative lows and highs (2): Technical analysis

Many use charts to find the lows and highs.

Here is a post on bottom-fishing: A trading set-up: Bottom-fishing 

The reverse can work for selling at the high.

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