What It Means to Buy Low and Sell High
One of the most popular Wall Street adages is that you should “buy low and sell high.” The idea is that when the price of an asset is trading lower it inherently offers better value, and you should therefore buy it. Similarly, when the price of an asset is trading higher it inherently offers worse value, and you should therefore sell it.
While this makes sense in practice, things aren’t that simple. Here’s why.
First, just because you are buying “low” doesn’t mean you are getting better value. The other alternative is that an asset is worthless, and therefore any price greater than $0 is equally bad value. Had you applied the “buy low” philosophy to Eastman Kodak or to Freddie Mac, you would have lost money. Therefore, the philosophy should be amended to read, “buy value.”
Second, just because an asset is “low” doesn’t mean it can’t go lower; similarly, just because an asset is “high” doesn’t mean that it can’t go higher. For instance, stocks were historically very expensive in the mid-1990s. In other words, stocks were “high.” But the “sell high” philosophy was a loser.
Also consider that earlier this year, Russian stocks — especially Russian small-cap stocks — were perhaps the cheapest in the world on a price-to-earnings and on a price-to-book value basis. Yet they have been among the worst-performing assets to own. Again, the philosophy should be amended to “buy value, and try to do so at a lower price if you can, but buying value at a higher price might not be a bad idea.”
The fact of the matter is that if you are an investor, your goal is to buy assets that are intrinsically more valuable than their market values. If you are a short seller, your goal is to sell assets that are intrinsically less valuable than their market values. The idea is that over time, this valuation disparity will be rectified.
If you are trying to time the market, then you are not an investor but a trader. If this is the case, then a “buy low and sell high” mentality might make sense, but at the same time, it might not. In fact, the best trading strategy might be to buy high and sell higher, or to sell-short low and to cover your short lower. Betting on continuing momentum is easier than picking the point at which momentum will change.
As an investor, I try to incorporate a form of the “buy low and sell high” philosophy in that I will pick assets I want to own in advance and will tell myself that if such and such an asset reaches a particular price point on the downside, then I will buy it. But at the same time, if I am convinced of an asset’s value I will just buy it, or, at the very least, I will assume that there will be a minimal amount of market volatility and try to take advantage by buying a little bit lower.
So, for example, if I want to buy a stock that is trading at $100 per share, I will assume that normal market volatility will probably, at some point, drag the stock down to $98 per share.
“Buy low and sell high” makes a lot of sense prima facie, but like any saying, it has to be properly contextualized and rationalized in order to be of any use from a practical standpoint. Investors who follow it blindly may find that their success rate is not nearly as high as they would like it to be.
But at the same time, completely ignoring it makes little sense as well. In all likelihood, if you are not aware of the advantages of “buying low,” you will wind up chasing upward momentum, and if you aren’t careful, that can be a recipe for disaster.
Disclosure: Ben Kramer-Miller is long Russian stocks.