If you’ve ever read books on investing, or even attended business school, you’re familiar with the prevailing philosophy of buying companies or markets that are fundamentally sound and avoiding those that are out of favor or have no prospects for future earnings. Generally, this is sound advice; however, the price we pay for these companies should also be a strong consideration. In other words, we should buy these stocks or markets when they’re cheap, and sell them when they become overpriced. Understanding when stocks become a value proposition, or too expensive, takes some skill that can only be developed by training and experience.
When I first began my career in the brokerage business in the late eighties, I was very naive about the financial markets. However, I always thought (in my naiveté) that when the market sold off – that was when all those good companies everyone talked about went on sale, and therefore was the best time to buy them. So not knowing any better, I would enthusiastically call as many of my clients (which at that time weren’t many) to purchase those good stocks to invest in. I thought that because everyone likes to get a good deal— you know, buy stuff at a discount— that they would be amenable to buying those shares; but much to my surprise, very few people wanted to buy. In fact, when the market had suffered through a protracted decline most people wanted to sell. Yes, sell at low prices…
Another aspect to the selling that I learned very quickly was that when our office was flooded with calls of distressed or panicked clients wanting to unload their holdings, without fail the market would mark a low within days, sometimes hours. Spending several years as a broker, this nervousness from the general investing public would be one of the signals I would look for when looking for major turning points in the market. Since I haven’t been in that business for many years, I have found other ways to track what the general public is doing because it still is uncannily reliable.
When it came to buying, these same clients that either refused to buy low (or actually sold near the bottom) would not be interested in buying until the market had been rising for some time. When the earnings were good and the economy looked promising, then, and only then, would they get comfortable enough to step in and buy. And invariably, this would be at the tail end of the rally.
If I were to substitute the word car, or expensive gadget in place of stock or market in the previous two paragraphs you would think it was utterly ridiculous that we would shun low prices and wait for the price to go up before buying wouldn’t you? The reality is that most novice traders and investors buy and sell financial instruments in exactly the opposite manner that they transact in general merchandise. You’re probably thinking that buying something that’s tangible such as a house or car is very different than buying a stock or futures contract. In some respects it is; however, buying low and selling high is the only sure way to turn a profit in any business. Finding where prices are low is where the supply and demand equation comes into play. And of course, there is never any guarantee that prices will hold at low levels, just like in any tangible item, but at least the risk is low to find out.
On Wall Street, financial institutions make billions of dollars in profits by buying low and selling high, and all the while the general public tends to under-perform the major averages over the long term.
Emotions are the primary culprit as to why the uneducated trader and investor tend to buy high and sell low. It’s as old as mankind, the emotions of fear and greed drive most people’s decisions when it comes to financial risk taking. In addition, conditioning by Wall Street and all the books full of “conventional wisdom” put people in the mindset of waiting for prices to gain in value before buying. The adage of “selling weakness and buying strength” is prevalent among many of these publications. The strategy of buying high and selling higher can work in the early stages of a bull market, however, most investors in the early phase of a bull market are not psychologically ready to enter the market.
The bottom line is that to be successful in any type of market speculation we must sell merchandise at a higher price than where we purchased it to make a profit. If this is so obvious, then why is it so hard to do? Start thinking like a good merchant (buying wholesale and selling retail) and perhaps your profits will be bigger and your losses smaller.
Until next time, I hope everyone has a great week.