Why Acting on Stock Price Can Be a Mistake
Buying low and selling high is investment advice that's been passed along for generations. It's the ultimate guide to successful stock investing and a virtual mantra of seasoned investors. Remove emotions from the equation. Invest for the long haul, even if that means decades.
What Makes Investors Buy High
Many investors do the reverse. It's not that they start with the intention of buying high and selling low, but far too often, they use price and price movement as their only signal to buy or sell.
Stocks that have gone up in price quickly—especially those in trendy industries with a lot of press—often attract even more buyers, which drives the price up even higher.
People get excited about what they read, and want a part of the action. Consequently, they jump into a stock that's already trading at a premium and end up buying while it's high.
What Traders Do Is Speculation
Experienced traders can make money by jumping in and out of a stock that's caught the public's attention, but it's not a game for the inexperienced, and it's not considered investing—it's speculation.
There's definite risk involved with spot trading, and tax consequences as well. So you have to know what you're doing.
If you hold an investment for one year or less, it's taxed at your regular income rate. If you hold an investment for more than one year, it becomes a long-term capital gain and the tax rate is usually less than your regular income rate. Depending on the size of your investment, this difference in the tax rate could prove to be a substantial amount of money.
Other issues are also involved, so most investors should leave this type of activity to experienced short-term traders who excel at it and know the tricky ropes. For most investors, trying to grab a piece of the latest flashy stock usually means paying too much and missing the benefits that initially attracted them to the stock.
Selling Low Can Be a Bad Decision
The other side of the market happens when a stock has fallen. Most investors immediately want to bail out, and they unload and sell along with the rest of the market. However, selling low can be a bad decision when you go by price alone.
A stock's price drops for many reasons, and some have nothing to do with the soundness of the investment. It's often just a matter of supply and demand, and this is usually a matter of waves of sentiment.
That's why you might miss an opportunity if you only follow the price. Investors are known to be irrational, so don't follow the herd and expect them to lead you in the right direction.
The period immediately after a stock's price has fallen can be a great time to buy low if you've done your research into the company, and particularly if you can identify why the stock's price is low.
Take the time to read the company's annual report and public filings made with the Securities and Exchange Commission. These can be found online in the Investor Relations section of the company website.
The Bottom Line
If all you know about a stock is its price, you might—and probably will—make investing mistakes. If a stock has had a good run-up, it might be time to sell, not buy, because you want to sell high and re-invest those gains in undervalued stocks. If a stock has dropped like a rock, it might be a good time to increase your holdings because the price is liable to rise again once the market settles.
You won't know what to do unless you understand and know a lot more about the company than just its stock price. What's important in the long-run is a company's fundamentals. Those will always outlast any irrational investor behavior.
Always consult with a financial professional for the most up-to-date information and trends. This article is not investment advice, and it is not intended as investment advice.