You Were Told ‘Buy Low, Sell High.’ You Were Told Wrong
Here’s the truth about when and how to buy and sell, and why much of it might seem counter-intuitive.
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Buy low and sell high. It sounds like simple wisdom dispensed by a grizzled veteran of the Wall Street wars. Of course, you make money if you sell for more than you paid. Go and do that, and you’ll be rich. The problem is that the saying tells you nothing about which stocks to buy, when to buy them, or when to let them go. The advice is not just empty. Both halves of it point you in the wrong direction.
A Low Price Tells You Nothing
The goal is not to buy at a low price. The goal is to buy when the valuation is attractive, and those are different things that get confused constantly.
Someone pulls up a chart, sees a stock trading at half its price a year ago, and concludes it must be a bargain. It is cheaper than it was, so it must be a better value than it was.
That reasoning treats the old price as if it meant something. It did not. The old price was what buyers and sellers agreed on under conditions that no longer exist. Maybe the business deteriorated. Maybe the industry changed. Maybe the old price was too high to begin with, which happens more often than anyone admits. A stock that has fallen 50% has told you exactly one thing, which is that a lot of people wanted out.
Price by itself carries no information about value. Value requires knowing what the business earns, what it is likely to earn, and what you are paying for those earnings. The stock that fell in half can easily fall in half again, and plenty of them do.
Great Stocks Spend Their Lives Making New Highs
The second half of the advice is worse.
Selling into a new high sounds like the responsible thing to do. You are taking profits and not getting greedy. Consider what that discipline would have done to you with Nvidia (NVDA). The stock traded in the $3 to $4 range in 2019 on a split-adjusted basis and it is near $200 now. Somewhere in that journey it made hundreds of new all-time highs, and every one of them presented itself as a chance to “sell high” and book a gain.
Selling any of them would have cost you one of the great runs in market history.
This is not a quirk of one stock. It is what winning looks like. A stock in a durable uptrend makes new highs constantly, because that is the definition of a durable uptrend. The stocks that never make new highs are the ones that are not working. Applied mechanically, the sell-high rule has you selling your winners and keeping your losers, which is exactly backward and is the most reliable way to guarantee mediocre returns.
Relative Strength Is the Screen
The better advice is to buy high and sell higher.
The reasoning starts with relative strength, one of the most useful indicators available but also one of the least intuitive. A stock that consistently outperforms the rest of the market tends to keep outperforming. Not forever, and not without interruption, but the tendency is persistent enough to build an approach around. In fact, William J. O’Neil of Investor’s Business Daily did exactly that with his “CAN SLIM” methodology.
Most people find this uncomfortable. Buying something after it has already gone up feels like arriving late to a party that someone else enjoyed. The instinct is to hunt for the thing that has not moved yet, which sounds shrewd but usually is not.
Why Momentum Feeds Itself
George Soros built a career on the idea he called reflexivity, and it explains why relative strength works better than it should.
The conventional view holds that a stock’s price reflects the underlying business. Reflexivity says the causation runs both ways. The price affects the business, which then affects the price.
The first loop is about perception. A rising stock is read as evidence that the story is correct. Analysts raise their targets to catch up with the price rather than the other way around. The financial media writes about companies whose stocks are performing well, which attracts new buyers. Traders who fear missing out arrive, followed by the funds that own things simply because they are going up.
The second loop is the part most people miss. A high stock price is a valuable business asset. A company whose shares are climbing can raise money cheaply, pay employees in stock that is worth something, buy competitors with paper instead of cash, and recruit talent that would not otherwise take the call. Customers sign longer and bigger contracts with a company that looks like a winner. Think about how the success of Nvidia as a stock has helped to boost its business prospects. A company whose stock is falling can do few of the things a company like Nvidia can do.
So the price move creates the conditions that justify the price move. That is why strength persists, and it is also why broken stocks stay broken far longer than the fundamentals alone would suggest. The same loop runs in reverse and it grinds slowly and painfully.
A New High Is an Alert, Not a Buy Signal
None of this means you buy a stock because it hit a new high.
A new high is an alert. It tells you a stock has separated itself from the pack and belongs on your watch list. What you do after that is where the money is made or lost, and rushing it is how people convince themselves that momentum investing does not work.
A stock breaking to a new high is usually extended. Buying at that moment means paying the highest price anyone has ever paid for it, with no support underneath and no level that tells you when you are wrong. That is not a trade. That is a hope.
What you do instead is wait and watch. Stocks that make new highs almost always consolidate. They go sideways for a few days or a few weeks, they pull back toward a moving average, they shake out the traders who bought the breakout and cannot tolerate a red session. That consolidation is your entry, and it offers something the breakout never did, which is a level to work against and a reason to exit if the stock stops behaving well.
This is what screening tools are for. The daily new-high list, relative strength rankings, and the various growth screens are not lists of stocks to buy. They are lists of stocks to start watching. Run them regularly, pull off the names that keep reappearing, and you end up with a working watch list built from stocks the market has already identified as leaders rather than from stocks you talked yourself into.
The repetition matters more than any single reading. A stock that shows up on the new-high list once had a good day. A stock that shows up week after week, in different market conditions, is telling you something important about who is buying it and why. That is the name worth stalking through its next consolidation.
The buying is incremental, as always. Momentum ends eventually, the loop reverses, and the leader that carried you for a year becomes the stock that gives it all back. A position built in pieces can be reduced in pieces without drama.
The Two Lessons
A low price has nothing to do with good value. The stock trading at half its old price is not a bargain because it is cheaper. It is a stock that a lot of people decided to sell, and until you understand why, the discount is imaginary.
A high price is not a signal to sell. It is a signal to start paying attention. New highs are what great stocks do, over and over, for years at a time, and the ones making them are the ones that deserve a place on your watch list. Do not underestimate the power of momentum, and do not let a piece of advice you heard on your first day in the market talk you out of your best position.
At the time of publication, DePorre had no position in any security mentioned.
