Timing the market is incredibly difficult. In the short run, the movements of stock prices can be exceptionally volatile. In many cases, an investor may be unable to find the opportune moment to buy or sell a stock. As such, they may look back with the benefit of hindsight and feel they could have done a better job when it comes to the timing of their investment.
Clearly, all investors are seeking to buy a company when it is priced low, and then sell it at a later date when it is trading at its highest level. However, through buying after its lowest point and selling before its highest point, it may be possible to generate high returns, while also limiting risk.
Buying late
Buying a stock after it has started to rise from its lowest point may not maximise total returns. However, it can significantly reduce the level of risk to which an investor is exposed.
In most cases, a stock trades at a low point relative to its past performance for a good reason. For example, this could be because of an internal problem that is set to affect its future profitability, or an industry-wide decline which is causing investor sentiment to fall.
Either way, it is almost impossible for an investor to judge exactly when a turning point will come along – if it ever does. Therefore, buying a stock which is currently experiencing a falling valuation may not be a sound idea. It could continue on its current path and lead to paper losses in the short run for the investor.
A better idea may be to wait for evidence of a shift in performance. This could be from an improved trading update or brighter outlook for the industry in question, for example. It may mean that an investor has a better chance of registering a profit as opposed to a loss, which could reduce overall risk levels.
Selling early
It’s a similar principle when it comes to selling stocks. Clearly, it is exceptionally difficult to know when a company’s stock price rise will come to an end. Even when it does, an investor may deduce that a fall in valuation is merely a volatile period from which the company in question will recover. And by the time a step-change in investor sentiment is identified, it could be too late to sell because capital gains from the purchases may have been severely eroded.
As such, selling a stock when it appears to be overvalued could be a shrewd move. Certainly, it may mean that returns are not maximised. However, it also means that there could be less risk exposure for the investor.
An improved risk/return ratio could be highly rewarding in the long run, and may lead to more consistent returns for an investment portfolio. As such, investors seeking to ‘buy low and sell high’ could stand to make significant returns by buying slightly late and selling slightly early.