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

Everyone knows “buy low, sell high”.

The low is often not obvious at the moment; it is only obvious looking back.

Some wait with a huge pile of cash for a crisis to crash the market to buy low; hoping to buy low and sell high. There are several psychologies and emotions that we should be aware of and the corresponding ironies created:

Our conviction has an upward bias. When the market goes lower, we dismiss them as pull-backs. As it keeps going lower, our conviction gets more shaken and our fears and doubts increase. We become more fearful that we may end up selling at the low and tune out of the market. Any positive news at the depth of the crash is not good enough to push through our walls of worry.
Bottom = Low but we know the buttom after we pass it; in hindsight. People associate the bottom with the low. We will not know the low at that moment. We only know the low is reached after we go higher from it. The ability to catch the low give bragging rights and many are fixated on catching the low.
The market can go lower than our expected low. Over a prolonged bear market, there can be a few relief rallies and bear traps. We agonise over our misjudgements, gripped with more fear and losses that we lose confidence. We get more tune out of the market. Buying low becomes an illusion.
Low = Maximum fear and uncertainty. At the low, the market has a high degree of fear and pessimism. It can be difficult to be rational and greedy to buy with high allocation. People myopically focused on the significant downside risk we faced to market lows. People shared charts noting the similarity between the bear market and some of the worst in history. Many are worried and fearing whether the companies will survive.
At times, depending on the severity of the crashes, the stocks get very cheap as the market seems to price them as being unable to survive. Will they?
Few take a counterintuitive and contrarian view that low = opportunity to buy low.
How much should the market go up from the low to confirm that the low has been established? Some are still gripped with fear; they can be lost and confused. Some may think it is a relief rally, a fake rally, or a bear’s trap again and they hate the rally as they have not been participating. Things in the real economy are still not looking good. Many do not believe we have passed the bottom. There are many different and opposing views with no consensus. Some may have lost hope and sold at the low. Some may buy at the low in small allocation fearing that the rally may not last; they took profit fairly quickly (buy low, sell a tad higher).
Depending on the severity of the crash, many 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?
Circular reference: The rally has gone up so much that it is too high now to buy. 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 increase from the low) that we felt the “buy low” opportunity is over. 🤦‍♂️🤦
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 and sluggish for some time. The market reaches a low with the worse being discounted. The market lacks positive catalysts to get excited to rally hard. It can be U-shaped, L-shaped or K-shaped where selected stocks rally and others remain sluggish.

How much will we be buying the lows? To buy in a few big scoops to have a meaningful portfolio allocation when we think the market is at a low is (very) difficult.

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

The above is a good observation of how many retail investors behave. Many may end up not buying low in the down cycle and even if they bought, they may not buy a lot, few will hold them to sell at the market high.

Often, our biggest challenge is managing ourselves. We are evolutionarily wired to run from pain and loss. Yet enduring these essential aspects of life and investing leads to growth, both personally and financially. In markets, our instincts kick in at the worst times.
Samantha McLemore, On Growth and Change, Opportunity Equity 2Q23 Commentary

The high is not obvious too.

Similarly, people want to sell as high as possible.

Our conviction has an upward bias and is not prepared for any downward price movement. 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. Any drops are ignored but persistent drops will caused anxiety as the price actions are contrary from our views.
High = Peak. We only know the high after we pass the high.
What if the market goes above our expected high? Do we sell higher?
High = Greed. We may not be rationale enough to sell a high allocation of our portfolio.
Valuations become too high and charts show very oversold.
Some may believe that the high = opportunity to sell/trim.
How much should the market plunge from the high to determine that the peak has been established?
What if the market does not hit our high and goes lower?
Circular reference: 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.
As the market falls from the high, it may not crash as we expect.

Let’s analyse this further.

Many are often more emotional than rational when the market is at the 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 that the market may go 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 become overwhelmed by emotions. We become biased — confirmation bias, anchoring bias, recency bias, groupthink, etc.

We should have a good plan to guide us during crashes and exuberances to manage our emotions and maintain our rationalities to buy low, and sell high. We need to do our research to validate whether the market is right or wrong. Here is where our investing criteria and approaches are important.

“Buy low, sell high” is common sense. It is NOT a plan.

It is analogous to telling companies to sell higher than the cost price to have profits 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 to invest with rationality and objectivity especially when we can get emotional (greed and fear) during the highs and lows.

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 whether we are investors or traders and our time-frames, the type of stocks we 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.

Traders mostly use price charts.
- They use charts to indicate reversals on the time frames they are trading on.
- Their lows and highs depend on the time frames they are trading on. It can be a few percentages within short time frames (lows and highs within the day, days, and weeks).
Investors study fundamentals and valuations. Their lows and highs are based on whether the stocks are undervalued or overvalued. Their time frames are usually months and years (or decades); going for much more percentage gains. Warren Buffett would look for a good margin of safety for his consideration to invest. 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.

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

Buy low ≠ Sell high

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 and faith matter.

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 the charts flash overbought that 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.

Buy and hold (time in the market) is easier.

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.

It takes time to know whether we are right.

It will take time to know whether we are right. Depending on our time horizon of the thesis, it can be a long wait to be vindicated and exceed our expectations. At times, we will be wrong. They do not play out as we expected them to do.

We just have to keep observing, learning and pivoting.

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:

Invest a fixed capital within every predefined period; buy $x every month
Invest a fixed capital with every % or dollar drop in the market; buy $x whenever the share price drops x% or $x
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.

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.