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Buy low, sell high [ClearOnMoney]
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Commentary

Buy low, sell high

5 Jan 2011 by Jim Fickett.

“Buy low, sell high” is widely misunderstood. Few actually follow the maxim, and all investors would do well to learn how to better apply it.

Everyone thinks they understand the maxim “Buy low, sell high”. In fact most people think it is so obvious there is not even any point in discussing it. The opposite is true. Not only do most investors fail to understand the maxim, but it runs counter to a large fraction, perhaps the majority, of investment writing.

Absolute, not relative

“Buy low, sell high” is often viewed as desirable but trivial, because it is interpreted to mean “make sure your selling price is higher than your buying price”. That would indeed be trivial advice. The substance of the saying, instead, is in the idea that you should buy when prices are low, in some objective sense, and sell when they are high.

The maxim is diametrically opposed to the momentum trading advocated by, for example, famed trader Dennis Gartman:

The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is “low.” Nor can we know what price is “high.”

The major news sources need for the daily blips to be important, so they are naturally oriented toward the trader's view of the world, in which one is trying to anticipate the moment-to-moment movements of the market. So it is easy, as an investor, to get caught up in such thinking, and feel that “buy low” means “buy now because tomorrow the price will be higher”. No. Contrary to Gartman's statement, there are ways, on a long-term view, to determine whether a price is unreasonably low or high, and the time to buy is when the price is low.

While the trader tries to anticipate the market, the investor takes advantage of the sometimes irrational prices that the market offers. Benjamin Graham, in his classic book “The Intelligent Investor”, puts it like this:

Imagine that in some private business you own a small share which cost you $1000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.

If you are a prudent investor or a sensible businessman will you let Mr. Market's daily communication determine your view as the value of your $1000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.

Not top and bottom

“Buy low” does not mean “buy at the bottom”, and “sell high” does not mean “sell at the top”. It is very easy to worry, when the price is low and one wishes to buy, that the price will go lower still. Yes, it is emotionally painful to buy and see the price go lower, or sell and see the price go higher. But, in fact, it doesn't matter.

If one buys well below intrinsic value and sells well above intrinsic value, one almost always makes money. That is enough.

What is, not what might be

Of course investment decisions are based on many things besides low and high price – for example, allowable risk, portfolio balancing, and one's idea of future trends. But to the extent that one is trying to determine whether the price is high or low, it is desirable to rely on real data, not guesses about what might happen in the future. This is because all of us make many mistakes guessing what the future may hold, and it is simply too easy to talk one's self into a high or low value, using scenarios that may or may not come to pass.

No matter what you think the future may hold, then, at least take a very serious look at the value of a stock in terms of past earnings, and the value of a commodity on the basis of past price ranges, supply, and demand.

Note on the origin of the maxim

I doubt anyone really knows who first suggested that one should buy low and sell high. The saying, at least, is obvious, even if few understand how to put it into practice. So in all likelihood some version of the saying is about as old as markets. But Nathan Rothschild, of the famous banking family is often credited with the saying. Here is one version of the story, from the Banker's Magazine in 1901:

”[a variant of the story] is to the effect that Nathan Rothschild ascribed the secret of his acquisition of wealth to the fact that he always bought “sheep” and sold “deer”.