The Problem With "Buy Low, Sell High"

Genia Turanova's picture

Tuesday, May 21, 2019 - 12:00am

by Genia Turanova

How to make money in the stock market? 

One answer, often said in jest, is to "buy low, sell high."

Of course, the "buy low, sell high" formula, while 100% correct, does not give us any real insights into the process of investing. That's because, on its own, it has little to do with the how-tos of the market.

Rather, it describes post-factum, how a typical profit is booked: you make money when a stock you sell is trading higher than your purchase price. This simplistic way of thinking about the market -- that, in order to make money, one has to "buy low" -- can probably be blamed for keeping some investors out of the rallying market.


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SPX 3-yr chart

Then there's another question: when is "low" is low enough? Investors who waited for the all-clear sign after the fourth-quarter selloff last year might not have gotten their chance over the first four months of 2019, either. As the market rallied 17.5% from the end of 2018 to the end of April, there were only three (yes, three) days when the market declined more than one percent. None of those mini-selloffs lasted for more than a few days (see the table below) -- in other words, none created a distinct "buy low" opportunity.

S&P selloffs and subsequent returns

So it should come as no surprise that the early-May selloff might be seen by some investors and traders as a buying opportunity. After all, the 4.6% decline from May 1 to May 13 (a decline that culminated in a 2.4% selloff on Monday, May 13) was the first such opportunity of the year.

Of course, this time might be different. That's because the most recent selloff was caused by a potential change in the economic outlook, stemming from new flares in the tariff war. The increased tariffs imposed both by the United States and China is the reason for the selloff (China said it will increase tariffs imposed on about $60 billion of U.S. goods in retaliation to the United States imposing an extra 25% tariff on thousands of Chinese products worth about $200 billion). With new massive tariffs, if no resolution is found, the economy might slow -- especially in the short-term.

The market bounce after the Monday selloff could be an indication that market participants still don't expect the trade war to be for real. Or, if it is, the market might be pricing in a fast resolution of the conflict.

But what if the market's bounce isn't indicative of anything other than just a temporary reprieve from ongoing weakness? Can investors do something to position themselves for all eventualities?

Prudent Strategies To Hedge And Protect
First off, this is the time to employ some hedges if you haven't done so yet. Over at Fast-Track Millionaire, we have two hedge positions in our portfolio that tend to move higher when the markets move lower or if volatility increases. One has exposure to gold, while the other is an ETF that holds zero-duration Treasuries.

I realize that may seem a little strange, since we devote the rest of our portfolio to the best high-growth potential picks on the market. But given the uncertainty on a macro level, it's a good risk-management strategy.

Further, now might not be the best time to "Sell high" -- or take some gains off the table. Still, we have done just that with some of our recent moves, and I will continue watching for more opportunistic gains to take.

In addition, there is always the "rule of half" for investors who feel nervous but want to stay invested. You don't need to leave the market altogether. Rather, you can reduce the size of some or several (or all) of your positions by some amount (it does not really have to be the exact "half"). Alternatively, you can reduce your market exposure by selecting the best stocks for your personal situation that you feel have the most potential and consider keeping a smaller stake in the rest.

This action also raises cash. And cash, as you know, is king in a volatile market: higher cash increases portfolio safety and allows you to keep some powder dry for when the market creates a clear "buy low" opportunity or for when you feel it's safe to be fully invested.

Action To Take
Long-term, investing is most successful when you are not trying to time the market. But many investors, especially those whose cash needs are pressing or who are in retirement and use their portfolios as a source of funds, could find some of the "middle-ground" suggestions I laid out earlier useful.

There is nothing wrong with a "Buy low, sell high" mindset. And, of course, there is also nothing wrong with buying high and selling higher -- momentum traders do this all the time. Both strategies are valid, and both -- in combination -- are used by us at Fast-Track Millionaire

This is why, in any market, we also look for new recommendations. Not every winning stock idea will come along in the middle of a smooth, low-volatility market. After all, our overriding goal at Fast-Track Millionaire is to find innovative companies that are so poised to fundamentally alter that the future looks like for the rest of us that it won't matter what the rest of the market is doing. 

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Genia Turanova does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.