Buy High And Sell Low: A Formula For Failure

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It’s unfortunate but true: Many people are not particularly successful investors. Why? Part of the reason can be explained in these two words: Fear and greed.

How do these emotions keep investors from making progress toward their goals? Let’s start with greed.

Too many people are mesmerized by “hot” stocks — those whose prices have risen substantially, often in a relatively short period of time. Instead of being satisfied with their gains, however, investors hang on to their shares, hoping they can wring more and more profits from ever-rising prices. But sometimes, rising stock prices are not indicative of high-quality stocks.

For proof, just look back a few years, to the late 1990s, when investors poured huge amounts of money into high-tech and “dot-com” companies, many of which had little to offer, apart from futuristic names and fanciful business plans. For a while, the stock prices of these companies just kept rising. But in early 2000, the technology “bubble” burst, helping usher in a lengthy bear market.

Now let’s switch to the other emotion that can harm investors: fear. Above all else, investors fear losing money — no surprise there. This fear often causes them to sell their stocks when the price has fallen, so that they can “cut their losses.”

In short, too many investors hear this advice: “buy low and sell high” — and then do just the opposite.

When to buy and when to sell

To avoid “buying high and selling low,” it would be helpful to know when a stock is going to reach its peak or valley. But no one can really predict these things — and it’s usually a bad idea to try to “time” your sales based on when you think a “high” or “low” is near.

Your investment professional can help you ask the right questions about why a stock is moving up or down. For example, is a stock rising due to hype, as was largely the case with the technology stocks of the late 1990s? Is its price-to-earnings ratio (stock price divided by earnings per share) unsustainably high? Or has its price gone up so long that some type of “correction” is perhaps inevitable? If any of these things are true, you might want to start thinking about the “sell high” part of the equation.

On the other end of the spectrum, you’ll want to know why a stock’s price is falling before you “bail out.” Are its products or services losing their luster? Does the company belong to an industry in decline? Is it experiencing disappointing earnings? Or is it merely the victim of a bear market, which tends to drag down most stocks, even the high-quality ones?

If this is the case — in other words, if you’re considering a high-quality stock whose price has fallen due to a down market or recession — you might actually want to buy more shares, not sell the ones you have. Warren Buffett, perhaps the most famous investor in the world, has made a fortune buying out-of-favor stocks at favorable prices. And even if you don’t achieve Buffett-like status, you can improve your chances of investment success by purchasing good stocks at good prices.

“Fear and greed.” “Buy low and sell high.” These are succinct phrases, but they say a lot about investing. Give them some thought.

Mike Blaes is a licensed financial adviser with the firm of Edward Jones. For more information, call him at (928) 476-6427.

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