One of the tenets of stock investing that the average investor, as well as the sophisticated day trader, has heard repeatedly is 'buy low, sell high'. Sounds like a reasonable approach to investing, right?
Unfortunately, it is much more difficult than it seems. This is partly because some rookie investors may equate stock investing with shopping at the mall. If a cashmere sweater costs $250 in December but has been marked down to $50 in July, then it must be a good deal, or have some type of value. Maybe so, but stocks are different. If the price of a stock over the last year or so has ranged from $24 to $60 a share and it's currently trading at around $26, it appears to be cheap - so, it's a good value, right?
Not so fast! Buying stocks that are near or at yearly lows may actually add risk to your portfolio, rather than reduce it.
Why Lows May Not Be a 'Deal'
A Different Spin on the Buy Low, Sell High Strategy
Some investors may want to adjust their strategies to 'buy high, sell higher'. That's not a typo. Many traders wisely look for stocks that are near their yearly highs and are in strong industries. There are many resources on the internet that allow the average investor to easily find a list of the strongest stocks and the best sectors. However, it should be noted that it is not a good idea to blindly buy stocks off of the new high list. (For more insight, read The 5 Biggest Stock Market Myths.)
Consider these reasons for buying relatively expensive stocks:
Let's take a look at a well-known company's stock chart over the last few years. In Figure 1, Exxon Mobil (NYSE:XOM) shows a long-term uptrend starting around October of 2006. The oil and gas sectors have been market leaders over this period. On the graph, each circle on the trendline represents buying opportunities along the way. Value investors may have been reluctant to purchase XOM at around $70 per share in early 2007 because at that time, this was near Exxon's all-time high. However, buyers of this stock were rewarded as the shares continued to rise.
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Figure 1 |
Source: StockCharts.com |
Conclusion
Some inexpensive stocks are actually true value plays and buying them will result in substantial gains. However, buying cheap stocks is not a risk-free strategy. In fact, your risk of losing money may actually increase over time as the stock loses value or fails to appreciate to your expectations. Consider buying strength, and get in on relatively expensive stocks. The risks are not as great as they appear and the potential for upside is consistently better than bottom fishing for inexpensive stocks.
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