Buy low, sell high. Most will agree it’s the simplest strategy in the world.
However, the fact it is simple doesn’t mean it is easy to execute, particularly when it runs counter to human nature. I am often asked for advice on investing and I always answer, “buy low, sell high.” I generally get the same response you are likely thinking: “Thanks pal, tell me something I don’t already know.”
My response: “If you are really buying low and selling high, you wouldn’t be asking for investment advice.”
Let’s start by describing why this simple advice is, in fact, counter-intuitive. Most people make investment decisions based on information from friends, or something read in the newspaper. The problem is, by the time the “average” investor hears about something, everyone else has heard about it too. If a lot of people already know the idea, there is a higher probability that the idea has appreciated in value by the time you buy.
Conversely, we sell stocks after we hear some bad news. If the “average” investor has heard the bad news, there is a high probability that most people have heard it, too, and everybody meets at the exit, generally resulting in discomfort for all. After all, it only makes sense to sell a stock after bad news, right? Who would want to sell when things are going great?
Now I am going to let you in on a dirty little secret. The “average” investor is no different than the professional investor. Information now moves so quickly that even professionals, who spend all day following stocks, can rarely react fast enough to “bad news.”
This is why most managers fail to outperform the general market.
So how do you beat these human instincts and make money?
Simple: buy low, sell high. The practical mechanics of executing this strategy aren’t complicated, but they do require discipline. Do as much homework as you can into an investment idea and set a price that you would be willing to pay. If it falls to that level, buy it. Counter to human nature, don’t worry if it falls further or never falls far enough for you to buy it. Unless your homework tells you something has changed, do not alter your buy point.
At the same time as you are deciding on your buy point, identify your selling point. For instance, if you think at a price of 20 times earnings you should sell half your position, then sell it. Don’t let your human nature talk you out of it.
The same theory applies for the mutual fund investors. Decide, with the help of an adviser, what percentage of your money should be in Small Cap stocks, Large Cap stocks and bonds. Once a year, see if you are sticking to that plan. If Large Cap stocks grow to such a point that they exceed your original levels by 20 per cent, sell some.
This re-balancing will ensure that you are constantly selling at high levels and buying at low levels.
If there is a down side to this strategy, it’s that sometimes you are going to buy things as they move down and stay down. Obviously, buying low and staying low is no way to make money. However, if you do proper, thorough, research in advance of making an investment, more times than not you will come out a winner.
Another thing that can drive people crazy is selling a stock only to watch it go higher. If that happens to you, remember that no one has gone broke making a profit.
A classic opportunity seems to be unfolding now in the semiconductor business. We have been believers in this sector since September, but it continues to fall. All the work we are doing tells us that now is the time to buy, but the market is screaming to sell. We have set our buy points and we now own a number of companies. We think we have the first part right, now we wait for the “sell high” point.
In addition to telling people to buy high, sell low, I tell them be patient. That may be the toughest part of executing the strategy.
(Evan Spiropoulos is a portfolio manager of the Norrep Fund, a public small cap fund managed by Hesperian Capital Management.)
