If you want to make serious money in stocks here’s how to do it: you have to buy when everyone else is selling. Do you think you can do it? Before you answer one way or the other, understand that it is not as easy as it seems. But if you can master it, you just might be the next Warren Buffett.
Buy when everyone is selling is the foundation of “buy low/sell high”
You’ve probably heard the saying, “buy low/sell high,” and that is pretty much what you are doing when you buy when everyone else is selling. This is how you handle the buy low side of the equation, at least. By buying when everyone else is selling, you have an opportunity to buy into the market at very low prices. It’s like buying stocks when they’re on sale.
Most investors follow the trends in the market. When everyone else is buying – which is typically when the market is rising – they’re buying too. And when everyone else is selling – which is when the market is falling – they’re heading for the exits with the crowd.
That can seem like an emotionally satisfying way to invest because you are following the herd, and there’s a perception of safety in numbers. But that’s hardly the way to make the biggest gains in stocks.
The payoff: sell when everyone else is buying
If you buy at or near the bottom of the market, the payoff comes when you sell when everyone else is buying. Not only will it be easy to sell your positions at your desired price, but you’ll have plenty of time to operate as the herd is panic buying out of fear of missing out on still higher price levels.
You might not time the market top exactly right, but if you bought in near the bottom, you’ll be locking in substantial gains anywhere near the top.
A recent example of buying when everyone else is selling
To show how much money you can make in stocks by buying when everyone is selling, let’s take a look at a very recent example.
When the financial meltdown took hold sometime in 2007, the stock market began a serious slide. After topping Dow 14,000 that year, the market took an elevator ride down. It finally bottomed at 6547 on March 9, 2009. If you were fully invested in the market at the high for the year and you held onto your positions during the meltdown, you took a loss of more than 50%.
But let’s say that as a certified buy low/sell high investor, you began liquidating your positions sometime just before, during and just after the market hit it’s 2007 high. You then stayed out of stocks for most of the ride down, opting to preserve your cash for a market bottom.
Round about the time the Dow dropped into the 6000s, you began buying stocks. From it’s low in 2009, the Dow is now back up above the 14,000 level. This means that based on the Dow alone, you have seen the return of over 100% in your portfolio in just four years – and that’s without taking dividends into account! And you could’ve accomplished this simply by investing in index funds.
By contrast, if you did what many people did, and held your positions from 2007, you would just be getting back to break even in 2013 – six years later. Worse, if you sold during the bear market, and didn’t buy back until recently, you would have locked in substantial losses.
The tough part is seeing the signs
2007 – 2009 was a very recent and an extremely impressive drop/rebound, but timing is the tough part. And if you get this wrong, the whole strategy goes out the window. But there are ways to see the signs, and to succeed even with less than perfect timing. Here are some markers:
S&P 500 Price/Earnings ratio. The average P/E ratio for the S&P 500 is right around 14. In bear markets it can drop to around half that. In bull markets will exceed 14, and often by a wide margin. The highest P/E ever for the S&P 500 was the peak of the Dot Com bubble, when it hit 40. That creates a wide range, but you can generally take a P/E ratio well above 14 to be at least one piece of evidence that the market is overpriced and may be due for a fall. Never rely on this exclusively however.
General market levels. It can seem simplistic, but the general price level of either the Dow or the S&P 500 can provide a strong sign. A market that has fallen by 50% or more is an above average bet for a major upturn. Conversely, when market indices have doubled in just a few years, yellow lights should be flashing. Complicating this however is the fact that markets usually overshoot in both bull and bear markets. A market that is ripe for a sell off at price level X, can easily rise another thousand points
Market sentiment. This is hardly scientific, but a telltale sign of a market top is when both the financial community and the investing public have complete confidence in the strength of the market. For example, back in the late 1990s, one of the major financial publications ran a big article declaring that the middle-class had come to view mutual funds as the new savings accounts. That’s over-confidence! But we all know what happened shortly after. Similarly, at the bottom of the market in 2009 many experts were confidently predicting a global depression. That’s panic!
A time of overconfidence is the sign to begin moving out of stocks. And when people are running scared and the talking heads are proclaiming doom and gloom, is the textbook time to move off the sidelines and start buying.
Controlling your emotions
If timing the market is tough, controlling your emotions can be even more difficult. You’ll have to discipline yourself to sell when everyone is sure that stocks are a can’t miss proposition. Even more difficult will be to be able to buy when most of the world is in a panic and looking to get out.
But if you can learn to see the signs, and to master your emotions enough to invest against the prevailing trend, the profits can be enormous.
Do you think you can do it?