The Great Paradox

It is an adage in the stock market that you should “buy low, sell high”. It sounds very logical to most people. After all, the most natural way to make money is to purchase a good at the moderate price and sell it to someone else at a margin. However, what everyone knows isn’t worth knowing and what everyone does isn’t worth doing. Some experienced investors do not consider it the best way to make money in the stock market, and even think that it could be a recipe for disaster.

William O’Neil (2009) conducted numerous investing seminars from the seventies to the nineties. In each one of them, he always asked his audience at which price levels they would start to buy shares. Over ninety-five percent of them were more comfortable buying shares which are substantially down from their recent peak. Almost none of them considered buying those that are making new highs in price.

Mr O’Neil also provided market research to institutional investors, and most of his customers are professional money managers. He found that most of them were bottom buyers too. They also felt a lot more secure to buy shares which had already gone down a lot and were selling near the lowest price in recent time.

According to his research in the stock market, however, O’Neil was unable to see how buying cheap shares could be a profitable strategy in the long run, at least not for small individual investors like you and me. He found that the companies which see their names on the new-high list tended to go higher, and those on the new-low list were likely to go lower. In other words, a company in the financial section’s new-low list is usually a pretty poor prospect, whereas one making the new-high list the first time during a bull market, given that there was a big increase in trading volume, might be a great buy.

Mr O’Neil called this the Great Paradox of the market. It states that companies which are cheap will go even less expensive, and tho ones which are expensive will get even more costly. Therefore, he suggested that an investor shall only go long as soon as the share price reaches a new high. In other words, he did not recommend to buy low and sell high, but to buy high and sell even higher.

It could be hard for most people to understand. Of course, you have to buy at a lower price to sell higher for a profit. However, it is often dangerous buy the minimum price at which the company has been trading historically. The market often pulls back far longer and deeper than people expect it to. There are usually a lot of despaired buyers who bought the shares at a much higher price and are desperate to sell them all when there is a rally, driving it even lower.

On the other hand, the best time to buy shares is when the price make a new high with substantial volume because no one wants to sell it, especially it is in an early stage of the bull market. In case if you are still uncomfortable, think about this. Tesla Motors (TSLA) is one of the greatest super-performers in recent years. In early 2013, it was trading between $30 and $40. On 1st April, it exploded up to $46.68 on enormous volume. If you are a “buy low, sell high” person, you may tell think to yourself, “It is a great company, but it is too expensive right now. I better wait until it falls back to $35 before I buy it.” Well, it did not. It only pulled back slightly for a couple of days and went all the way up to $194.23 in just six months.

As Jesse Livermore (1940) said, it is not as important to buy cheap as to buy right. Therefore, your job is not to look for a bargain, but to enter the market when the price has just reached a brand new high which scares the ordinary investors. It is often a point of no return which starts an incredible run.

REFERENCE:

Livermore, J. L. (1940). How to Trade in Stocks: The Livermore Formula for Combining Time Element and Price. New York: Duell, Sloan & Pierce.

O’Neil, W. J. (2009). How to Make Money in Stocks: A Winning System in Good Times and Bad (4ᵗʰ edition). New York, NY: McGraw-Hill Education.