Reader Responses: Buy High, Sell Higher or Buy Low, Sell High
The other day, I posted some thoughts on why I bought more shares of XFML after the stock plummeted to below $7. I didn’t apply any *technical analysis* or anything like that before making the trade and my reason was quite simple: nothing really changed before and after the sell off and the price became very attractive at that time. And I hope any rebound could help me cut my losses.
After the post was published, I got a couple of responses regarding my trading strategy (whether I am chasing a losing stock). First Any says:
never, never add to a losing trade. Don’t get stuck on the old “buy low, sell high�? maxim. An equally worthy objective is to buy high and sell higher.
Then James responses with the following comments:
The problem with “buy high, sell higher�? is that you don’t know when or if something will be going higher after you buy it. You can analyze it all you want and apply several sets of criteria, but the bottom line is that the market is fickle and no one can predict with certainty and accuracy that any one stock will continue to grow.
Still think that adding to a losing trade is a bad idea? Imagine this situation: stock X was at $10 per share, then plummets to $5 per share. An investor who bought at 10 shares at $10, now buys 10 more at $5 for a total investment of $150. If the investor is right and the stock eventually reaches $15 per share, his total now is $300 ($150 profit). If he is wrong, and the stock becomes worthless, he loses $150.
Same investor now tries the “buy high, sell even higher�? approach, buys 10 shares at $10 per share of stock Y. The stock then rises to $15 per share. He figures that the stock will go higher so he can afford to “buy high�? and buys 10 more shares. He now has invested $250. Let’s say he is right and the stock goes to $20 a share. He sells all and gets $400 for a profit of $150. Sounds pretty good right? If he is wrong though and the stock becomes worthless, he lost $250 ($100 more than the buy low sell high strategy).
Notice the relationship here between potential losses and gains.
In short, by buying stocks LOW, you can minimize your losses (since you didn’t pay much) if the stock tanks and maximize gains if the stock excels. Buying high and selling higher is nearly impossible to do with any consistency and doesn’t really give more advantages return-wise.
Some of the greatest investors like Benjamin Graham, Warren Buffett, Bill Miller, and others have all advocated the “Buy Low, Sell High�? approach, but who advocates the “Buy high, sell higher�?? The guys on CNBC’s Fast Money…. and that is not a good thing (if it works so well, they would all be billionaires).
Besides XFML, I had another experience with a “losing” stock and it is Nortel (NT), the stock that I have bought multiple times and never got out of the hole. I first bought 1000 shares at $6.67 (before the 10:1 reverse split) in January 2004 when the stock was climbing. Shortly after that, the stock dropped like a rock. Then in May, using the same thoughts with XFML, I bought some more at $3.97/share and more five months later at $3.27 a piece. Today the stock is traded around $25.64 (equals to $2.56 before the 10:1 reverse split) and I have no plan to add any more since I feel Nortel has much bigger problem than XFML does.
So what would you do if the stock you recently bought lost 50% of its value in a matter of weeks? Get out before it’s too late or add more and hope for a rebound?
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