"Buy low, sell high" is a famous investing adage about taking advantage of the market's propensity to overshoot on the downside and upside. Although it is very simple, it is difficult to execute. It is easy to say whether a certain price is low or high in retrospect, but in the moment it is monumentally difficult. Prices affect the psychology and emotions of market participants.
For this reason, "buy low, sell high" can be challenging to implement consistently. Traders can use tools, such as moving averages and the business cycle.
Difficulties in Buy Low, Sell High
There are famous examples of the market being driven to extremes, whether it is high prices during market bubbles or low prices during market panics. These proved to be excellent opportunities to buy low and sell high. However, there have been countless times when the market keeps trending in one direction, punishing those looking to buy low or sell high. What looks like high prices one day may look like low prices another day.
Traders and investors must have a certain objective method to determine if prices are high or low. Humans are conditioned to follow the crowd. There is inherent difficulty in consistently buying low and selling high. When prices are low, sentiment tends to be overwhelmingly negative towards a stock. Many bullish holders are forced to dump their shares. Similarly, when the price is high, it is difficult to conceive of letting go of a winner.
"Buy low, sell high" is misleading in some ways, as lows and highs only become clear in retrospect. There is always a bull who considers a stock price low and a bear who considers it high. Often, both sides make compelling arguments. The challenge for investors and traders is to determine which stocks are being driven to extremes by fundamentals and which are being driven by emotions. Mean-reversion strategies are more likely to work when price moves are driven by emotions.
One simple way to implement a buy low, sell high strategy is with the use of moving averages. Moving averages are derived solely from price, and they are helpful in helping traders and investors determine a stock's trend.
Using a moving average of a shorter duration and one with a longer duration can assist in helping traders buy low and sell high as well as protect downside risk. For example, one common method is to use the 50-day and 200-day moving averages. When the 50-day moving average crosses the 200-day, it generates a buy signal. When it crosses the other way, it generates a sell signal.
This is effective in helping a trader time his entry to the point when the trend is faltering. One issue for buy low, sell high strategies is buying or selling before the trend has fully exhausted itself. This approach sidesteps the issue.
Business Cycle and Sentiment
An approach to buying high, sell low, more suited for long-term investors is to use the business cycle and sentiment surveys as market timing tools. The market follows a rather consistent pattern of moving from fear to greed over long periods of time. Times of maximum fear are the best time to buy stocks, while greed is the optimal time to sell high.
These extremes take place a couple times every decade and have remarkable similarities. These emotional cycles follow the business cycle. When the economy is in a recession, fear predominates as economic activity decreases. This is the time to buy low.
When the business cycle is in its expansion phase, economic activity is increasing. Typically, people are feeling optimistic about the future. This is the time to sell high. Sentiment surveys such as the Consumer Confidence Survey provide further insight into the business cycle. If you don't already have a trading account and would like to try your hand at the buy low and sell high strategy, feel free to check out Investopedia's list of the best online brokers to help you choose a broker and get started.