Would you agree that Buy Low & Sell High is one of the best approaches to investing in the stock market?
I am sure most of you would agree!
We Indians, love to buy stuff at a discount. From haggling with a street vendor to negotiating with a departmental store, we want to buy things at a lower price, right?
I buy branded clothes, shoes & other things when they are available at a discount! There’s no shame in it!
Why should the stock market be any different, right?
With the same mentality, we enter the stock market and buy the stocks which are “Cheap”.
But sometimes we forget the difference between “cheapness” in terms of price and its intrinsic value.
We are tempted to invest in “Branded” stocks like YES BANK, Tata Motors, Indiabulls Housing, ZEEL, Indusind Bank and the list can go on and on! We assume that they must have become cheap because the price has corrected a lot!
Don’t believe me?
Remember what the sage of OMAHA, Mr. Warren Buffett said?
“ I like to buy quality merchandise when it’s marked down”
Millions of people follow his advice and the result is we end up holding a bunch of lemons!
Before you throw rotten tomatoes and eggs on me, let me try to explain!
What Mr. Buffett has said is true in every sense but it’s not applicable to retail investors!
Why?
There’s a major difference!
Mr. Buffett is investing in businesses and not in individual stocks!
Also, he buys in huge quantities and in many cases, has a board seat in the organization!
When you want to buy a business, would you want it to be fairly valued if not cheap?
And Invest heavily in the business if you think it has the potential?
Yes of course!
Now, would you want to buy a business with a view to hold it for 2–3 years and then get out?
Most people can’t even wait that long and those who do wait invariably have positions that are stuck.
The reality is that the cheap gets cheaper!
But don’t just take my word for it!
Let’s run a simple test to settle the debate…
Rules:
1. Buy 50 stocks that have closed down below 200 Day Moving Average by 30, 40, 50%. If you have more signals, Rank stocks that have closed the farthest below the average.
2. Exit on close above 200 Day Moving Average.
That’s it! Simple!
The stock closing 30, 40, 50% below 200 Day Moving Average must be quite cheap & must rally right?
This is a classic value investing type approach but we are only looking at the price for the moment assuming there would be some really, “Cheap” stocks based both on Funda & price.
Makes sense?
Let’s check out the below example to understand the rules…
Alright, let’s see what the test results have to say…
WTF?
Our beloved strategy of buying low & selling highs has been a loser strategy since 29/12/2006.
You have every possible right to doubt the above results!
But that doesn’t change the truth!
The fact is buying losers has been a loser’s game!
Now, what if we did the exact opposite?
What if instead of buying low & selling high, we buy high & sell even higher?
Now, this approach goes against our basic psychology & that’s why it’s hard to do.
Who in their right mind would want to buy stocks which have already risen so much?
Let’s see how buying high & selling higher fares…
Rules:
1. Buy the top 50 stocks which have closed above their 200 Day Moving Average by 30, 40, or 50%. If you have more signals, rank from highest to lowest in terms of the distance from the average and buy the top 50.
2. Exit on the close below 200 Day Moving Average.
That’s all! Let’s see the test results…
Buying high selling higher crushed it! That too by a wide margin!
All the variations significantly outperform buying losers!
Why because winners continue to outperform!
For, example, would you bet your money on Akshay Kumar or Shahrukh?
I hope you said Akshay because I would bet on him. He is on a roll right now! On the other hand, Shahrukh, no matter being a superstar, has not been able to perform lately!
Who doesn’t like winners?
Then why do we like losers when it comes to investing!
The reality is that the cheap gets cheaper!
Why is that?
Let’s just think about it!
The prices are simply a function of the demand and supply of the product!
This is economics 101 right?
It’s just like any other business!
You sell something at a higher price than you bought for!
Now, it’s common sense that you’ll only be able to sell it for a higher price if there’s a demand for the product which is higher than the available supply!
For example, let’s say, Stock A is making new lows while Stock B is making new highs!
Which one do you think is in demand right now? Stock A or B?
It’s the one that is making new highs, right? i.e, Stock B.
Why is the stock making new highs?
Simply because the demand for the stock outweighs the supply!
As the price of the stock rises further, it draws more & more buyers and so on! Eventually, the supply will overcome the demand or the demand would plateau which will bring down the price. But as long as there’s a demand for the stock, the stock should continue making new highs. Period.
That’s Momentum Investing for you!
We are not concerned with why there’s a demand for the stock! That’s the job of the analysts to figure out!
Now, if you pick Stock A over Stock B, you’re buying the stock which has more supply than demand!
For you to be profitable, you will have to anticipate that there’s going to be a lot of demand for the stock going forward.
Most people fall into this category!
They are the so-called Value Investors!
But for this way of investing to be profitable, you need a crystal ball which very few people have!
And those who do are ‘Outliers’.
Those are the Buffetts, Damanis, Jhunjhunwalas of the world!
For the rest of us, it’s good enough to know the stocks which are in demand right now! Not the ones, which will be in the future!
Summary:
As evident from the test results, buying losers have been a loser’s game. But don’t just believe what I say. There has been a tremendous amount of academic as well as practical research that suggests Buying High & Selling Higher has been a profitable strategy.
P.S.
I am hosting a workshop for a small group of 30 people on 16/01/2021.
Momentum Investing Masterclass.
Beat the markets with less risk, time & stress!
Check it out if you want to ace momentum investing!
Quite interesting. But I am not able to join this time. I have noted it for the future. Thanks.
Sure! Thank you!