Buy low, sell high – it's not that easy
Investors are repeatedly told to buy low and sell high. In the abstract, this famous adage makes perfect sense. However, it can be monumentally difficult to execute successfully. The market is configured to make you do the exact opposite: to buy high and sell low. For example, when shares are cheap, it’s normally because there is a strong sense of fear in the market. This is caused by a negative narrative around certain events or the current economic environment, and how shares will be affected. Consider the collapse in commodity prices in the second half of 2015. Markets were in a tailspin, and buying commodity stocks during this time made investors extremely uncomfortable. Glencore, one of the largest natural resources producers and traders in the world, was on every investor’s “sell” list. Analysts were saying that it was on the brink of going out of business and would require re-capitalisation. Asset managers that held the stock came under heavy criticism. Buying low under these circumstances would have been very difficult indeed. But investors who were able to look through the negative narrative and recognise Glencore’s strong fundamentals were handsomely rewarded when its price recovered in the months that followed. Similarly, when the narrative is very positive – when there is good news surrounding a stock, sector or economy – it’s difficult to sell. In 2007 and the first half of 2008, investors were reading about the rate at which China was urbanising and the incredible impact this would have on commodity markets. Although there was some truth to this narrative, commodity prices and related stock prices were hugely mispriced at the time. But amid the good news, investors were reluctant to sell them.
Ironically, investors will perceive the risk of investing to be lower when the story is strong (and prices more likely to fall) and perceive the risk to be high when the story is poor (and prices more likely to rise). Another strong narrative has developed around the global technology super-giants. These are businesses with excellent fundamentals that are dominating sectors of the technology industry. It makes it very tempting for investors to buy them, and very difficult to sell current holdings. But investors also need to consider the price at which they’re investing – do the share prices fairly reflect these companies’ fundamentals? If you are disciplined about buying low and selling high, it will mean sitting in cash (from overvalued holdings you’ve sold) while you wait for opportunities to invest in undervalued, high-quality securities. This can also be uncomfortable, because cash generally delivers inferior real returns relative to riskier asset classes. However, this is a one-dimensional view on the asset class. The true value of cash only reveals itself when the market panics, and investors need it to buy a strong position in an outstanding company at an excellent price.
Credits : IOL Personal Finance.
