Buy Low, Sell High Still Works

As I did my usual electronic reconnaissance of the world and the markets on Thursday, I noted that Josh Brown had sent out a tweet linking to a passage from the classic book Where Are All the Customers' Yachts? by Fred Schwed.

If you have never read this book, order it today and marvel at how Wall Street and its customers have not changed much in almost 100 years! The book was published back in 1940 and looks back at a period starting in the boom years of the 1920s. The passage is a piece of advice given to investors that is as useful and as ignored today as it was then.

The passage basically states that if you want to be rich you should sell all your stocks when common stocks are all the rage. They will probably keep going up after you sell them and you might even feel a bit silly at first. But resist the urge to jump back in.

When the inevitable occurs and the market reverses directions and no wants to own stocks for any reason, take your cash and buy stocks. They will probably go down for a bit after you buy them. But they will eventually reverse course and go much higher. The author concludes by saying, "Continue to repeat this operation as long as you live and you'll have the pleasure of dying rich."

This is not exactly new advice. The old French Proverb to "buy on the cannons and sell on the trumpets" is a few hundred years old at least. It was in the late 1880s that John D. Rockefeller suggested that "The way to make money is to buy when blood is running in the streets."

From the minute we are exposed to the stock market for the first time in our life we hear the sage advice to buy low and sell high. It has been reiterated over the years by people like Sir John Templeton, who advised us to buy at the point of maximum pessimism. Warren Buffett has ascribed much of his success to the simple fact that "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."

My favorite reminder of this simple path to prosperity is Mr. Womack the pig farmer, introduced to us by John Train in a 1978 Fortune article. Our friend the farmer ignored the markets until the news was dark and gloomy and pundits were discussing disastrous stock market losses. At such times he would drive into town and purchase a bundle of stocks. If market fell a lot more, he would drive back into town and add to his bundle.

In a few years when happy days were here again, he drove back in town, sold his stocks and went back to farming. The man never lost money in the market. I like this story so much I had a bunch of t-shirts with What Would Womack Do?" emblazoned on them to always remind me of the right course of action when buying stocks.

It is old advice and it has been the source of some of the largest fortunes in the history of the world. Yet almost no one pays any attention to the idea of buying low and selling high. Every day I see people trading stocks like they were playing roulette in a casino somewhere. I talk to individual investors who honestly believe they can out trade the rocket scientists and super computers that dominate short- term activity. This belief usually lasts right up until the last chip -- oops, I mean dollar -- is gone.

When the market is collapsing like it was back in 2003, or more recently in late 2008, no one is willing to step up and buy stocks because they were overly bullish in 2000 or 2007 and lost a ton of money. They are gun shy and afraid to commit any more money. They tell you the game is rigged and the little guy cannot win at such time.

Wait a year or three and these same people will be rushing to buy into the hot new social media stocks as they move higher after an extended bull run. They consistently undervalue risk on the way up and over value it on the way down. Instead of buying fear and selling greed they give in to their lizard brain and become part of the horde that does very badly in the stock market.

If you use valuation as your guide to the market you will be able to conquer the fear and greed cycle once and for all. When there are lots of safe and cheap stocks odds are the market will have been falling for a while and you can buy with abandon. When the opportunity set is shrinking near market tops, you will be building cash levels. It is a natural market timing guide.

Buy low, sell high works very well. You should try it some time.

At the time of publication Melvin had no positions in stocks mentioned.