Buy high, sell low
QUESTION: I feel that the stock market is a bit toppish and that it may not have enough stamina for another run up for the rest of 2014. What do you recommend that I do with my portfolio? posted at PFA’s “ask a friend, ask Efren” service at www.personalfinance.ph
Answer: You must have heard of the saying, buy low and sell high. Every bit of the saying is correct. However, investing in the stock market is much more than buying low and selling high.
Economists discovered this illogical pattern of behavior: People tend to quickly sell winners and hold on to losers. They call this behavioral pattern the disposition effect. This is partly explained by the prospect theory where people do not like to lose.
Selling the winners quickly will help lock in the gains now and avoid the prospect of losing money should prices head south. In Pilipino, this is called “naniniguro at baka mawala pa.” On the other hand, holding on to losing investments would avoid incurring losses now and may even open the possibility of the investments recovering and at the very least selling at breakeven later on.
Logically, however, an investor should keep his winners and even buy some more of them. This is why peso cost averaging works. With a fixed peso amount, an investor buys more of a good investment when the price is low and less of it when the price is high. But he continues to buy that good investment nonetheless.
On the other hand, an investor should jettison his losers. As I have written before, Jesse Livermore once said that the moment you incur a paper loss of 10 percent, you should sell that investment. He said that perhaps you probably were not in the best disposition when you made your choice. He recommends that you get out of your position and even the stock market. Believe it or not, he said that you don’t always have to be invested in the market.
So in essence, you continue to buy high (only the good investments) and sell even at low prices (the bad ones). In short, buy high and sell low. So as not to confuse you, buying high and selling low pertains to separate investments. Buying low and selling high pertains to just one investment.
The next task, therefore is to separate the good investments from the bad. Buying low and selling high is a product of another theory in behavioral economics, that of thinking in relative terms. Now there is nothing wrong with using benchmarks to see if we are doing OK or not. Doing comparisons is something we need for survival.
But the investor must employ a forward looking stance on top of his buy low, sell high strategy. In other words, a stock’s price should be considered low or high in relation to its prospective level and not just its historical performance. Such prospective or target prices can be determined from carefully crafted company reports and technical analyses.
Stock brokers come out with such extensive studies. And the larger your portfolio, the more stock brokers will offer you their reports. There are also free online reports and technical analysis tools provided by Reuters (www.reuters.com) and Bloomberg (www.bloomberg.com), respectively. To search for company reports for Philippine stocks, enter the stock symbol and ”.PS” for Reuters or ”:PM” for Bloomberg in their respective search box engines.
Of course, a good understanding of such reports and tools is a prerequisite. You cannot expect to separate the wheat from the chaff of your portfolio if you cannot comprehend such company reports and technical tools. So take the time then to study the fundamentals of investing and technical analysis. There are many books both online and hardcopy as well as local training programs that you can learn from so that you always end up with a golden portfolio.
Take it from Robert Frost when he wrote, “Nature’s first green is gold, her hardest hue to hold. Her early leaf’s a flower; but only so an hour. Then leaf subsides to leaf. So Eden sank to grief, so dawn goes down to day. Nothing gold can stay.” Robert Frost was referring to the sunrise and how majestically golden it starts out to be, but only to quickly lose its luster. Your stock investing will be headed in a similar way if you invest mainly on tips or on the latest trend (i.e. behavioral economics theory of herd mentality).
Finally, at the risk of sounding like a broken record, investing is just a tool. Always relate your portfolio return targets to what your ultimate financial goals are. Money is never the target.
If you want to get more free investing lessons, please visit www.personalfinance.ph. You may also attend one of the free EnRich™ Cash, Debt, Risk & Wealth training runs happening at a city near you. Details for the training may be found in www.personalfinance.ph.
(Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines, personal finance coach, seasoned investment adviser and bestselling author. Questions about the article may be sent by SMS to 09175050709 or e-mailed to [email protected]. To learn more about the RFP program, attend a FREE orientation on July 17, 7pm at the PSE Center. E-mail [email protected] or text <name><e-mail><RFP> at 09173464126 to register.)
