The stock market has performed poorly for most of this year. The S&P 500 Index is down 17.2% since the start of the year after recovering from more significant losses and a bear market. Recently, though, there has been evidence that one classic stock market investing strategy might be performing well again. That strategy is to buy low and sell high.
But before October, many bullish short-term investment strategies have performed poorly for most of 2022. Moreover, there haven’t been many opportunities to profit from buying stocks using these approaches since very few have gone up in value.
The buy low and sell high strategy is cliché. It sounds easy enough but investing in this manner can be difficult and risky for inexperienced investors. They are often unable to determine when to buy or sell. A declining stock price can go lower. Moreover, a short-term rally can be a dead cat bounce, meaning it will soon reverse itself and head lower, causing unrealized losses. However, some make it work, and even Warren Buffett practices the method.
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Buy Low, Sell High Investment Strategy
Throughout history, there have been a variety of documented investment strategies that could have made money in the stock market. Many of those strategies revolved around buying low and selling high.
The strategy relies on the fact that stock prices fluctuate because of economic conditions, geopolitical events, company-specific issues, and the natural business cycle. Certain types of investors take advantage of market volatility to follow a buy low and sell high strategy following data-driven and statistical methods. In fact, research has shown that since 1951, there have been more positive days than negative days. Furthermore, the percentage of up days has been increasing in recent years, with the highest percentage in the 2020s.
Over the last century, every time the stock market’s value went down, it has always eventually gone back up. The stock market’s historical upward pull has acted like the reverse of gravity.
With that sort of upward bias, buying low and selling high may have often proven profitable over the last hundred years.
Many value investors, such as Warren Buffett, have had tremendous success employing an investing approach like that over longer-term time frames.
There is also evidence that buying low and selling high can be effective in shorter-term time frames in many of the most common stock market conditions. For instance, according to stock market research, when an up-trending stock fell back to its average price, more than 55% of the time, the price went up within a week after that.
Pros of the Strategy
- Potential to generate high returns, especially when the market declines steeply in a short time, like during the COVID-19 bear market.
- Buy stocks at a discount, benefitting when they return to the mean. This approach is akin to buying the dip or averaging down stock.
- Trading costs are minimal to zero, so they do not provide a headwind for total returns.
Cons of the Strategy
- It is difficult to determine when to buy low and sell high because it is a form of market timing, especially if not conducted with the backing of data or statistical analysis.
- Investors may spend time sitting out of the market, and some research suggests missing the best days in the market reduces returns.
- Following the herd can result in a buy high and sell low strategy, which is a recipe for disaster.
Ineffective Strategy for Most of 2022
Buying low and selling high has not worked well in many cases this year, particularly on shorter-term investing horizons.
For example, suppose someone bought a market exchange traded fund (ETF) such as SPDR S&P 500 ETF Trust (SPY) when it was down 5% from its all-time high in January of 2022. In that case, there are very few ways the investment could have ended up profitable for a shorter-term time frame, such as a week, month, or quarter.
In prior years, such as 2021, a strategy like that could have been more effective. The stock market had a net positive return that year, which has happened more often than not over the stock market’s history.
This year has not been typical by historical standards. Instead, a relatively long, drawn-out market decline has led to losses for many people looking to buy low and sell high.
That has caused reluctance by many to continue employing such an investment strategy for shorter-term time frames. Buy-and-hold long-term investors might be pretty content with taking on stock positions right now, but there has been a lot of uncertainty this year for those looking at time frames between a week and three months.
Effective Strategy Recently
After being ineffective for most of 2022 by many counts, an investment strategy of buying low and selling high has proven to be more effective in the recent past.
One measure is simply that the S&P 500, a primary stock market index, has gone up 9.9% since October 17. That means buying any dips in market value between then and now may have had favorable odds of turning a profit for shorter-term investments.
The recent success of this investment strategy is evident by looking at the trading ledgers of stock market professionals who use it. Eric Ferguson of Mindful Trader is an example of a professional that scans for stocks and options that meet his algorithmic criteria for buying low and selling high.
His trading ledger since October 17 reflects 15 winning trades and two losing trades following the strategy. Each of the trades lasted one week. They are verifiable, demonstrating that buying low and selling high may have been an effective investment strategy since the middle of October.
When asked about the recent success of his investing approach, Ferguson said,
“My trading strategy is performing better now than it has at any other point this year. The market’s condition seems to be different now, at least for the time being.”
Possible Bigger Implications
With this classic investment strategy showing signs of potential profitability over the last month, it might signal that the stock market environment is amid a return to stability. The stock market has maintained an upward march in price after every dip in market value since the middle of October, which is reflective of a more typical market environment by historical standards.
If there is one thing this year has shown us, though, there is no guarantee of what will happen next in the stock market. So even though the past month has exhibited signs of strength for an investment strategy like this, it certainly does not guarantee it will continue to do so in the near future.
It also does not mean that the market has bottomed out or can only go up from here. All that can be said with certainty is that there is evidence that an investment strategy of buying low and selling high has shown signs of profitability in the recent past.
Disclaimer: The author is not a licensed or registered investment adviser or broker/dealer. He is not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
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