Want to Buy Shares Cheaply? Don’t Do This
Everyone loves a bargain. It could be a half yearly clearance or a humble garage sale. A big discount can be hard to resist. The Boxing Day sales are a classic. Long lines snake around street corners. The prospect of nabbing a bargain is often irresistible. People want to buy as soon as the price drops.
But should you approach the stock market in the same way?
A famous market saying is ‘buy low, sell high’. Now, you may think ‘buy low, sell high’ sounds obvious. That’s how you make a profit, right? But how do you define buying low?
Well, many people believe buying low means to buy when prices are falling. Sure, this strategy may work well for consumer goods. But does it stack up in the stock market?
What if you approach the market like a Boxing Day shopper? Instead of paying more for strong stocks, you search for bargains that have been falling in price. Many people prefer to buy shares this way. They’ll target stocks that have been declining. Their reasoning is that the worst has passed, and that better times lay ahead.
But does this strategy stack up?
Well, I’ve done some back-testing to find out.
Here’s what I did… I put together a basic system for buying shares. There was only one key entry rule: A stock must be trading at a three-year low. That’s right, a three year low. I also set a minimum entry price of 20 cents. And the system uses Motion Trader’s exit strategy that lets profits run and cuts losses. Each trade is set at $1,000 and the simulation is over a 15 year period.
What do you think will happen? Will buying at a big discount be a winner?
Okay, check this out:
Is this what you were expecting?
The strategy is anything but a shopper’s paradise. Forget about snaring a bargain — buying stocks “on sale” is often a trap. The approach is barely in the black after 15 years.
So, why is this strategy an epic fail?
Well, quite simply, it’s trading against the trend. People who buy a falling stock are betting they know more than the market. But the reality is often the opposite.
I’ll give you an example… I found an interesting article while preparing for this video. It was published by a popular research firm and was about potential bargains for the year ahead.
Here’s how it went… the equities analyst put forward three stocks. All were large household name companies trading near their lows after big falls. To many people, this spells “bargain”.
This was his first pick:
This is the share price for building materials firm Boral. The analyst said the shares were buy after a 39% collapse. What do you think? Does the big share price discount tempt you?
This is where the shares are now:
Not a great result. The bargain hunters made the mistake of buying into a downtrend. This often proves to be an expensive lesson — a cheap stock could get even cheaper.
Here’s the next stock on the list:
This is agricultural chemical company Nufarm.
Now, the research firm identified several positive catalysts for 2019. And with the shares down 36% from the year’s high, it may seem like a good time to buy. But look at the moving averages on the graph. You’ll see they’re both declining. The stock fails my first buying criteria — the shares are in a downtrend.
Let’s wind the clock forward 10 months:
This was another poor outcome. Nufarm may well be an outstanding buy one day. Some of the best performers are down-and-out-stocks that return to favour. But wait for signs of a trend change. Your odds of success are generally better when you buy into strength.
The analyst’s final stock results in a modest win. But the overall result is still poor. While you could get lucky with this approach, it’s like playing with fire.
Sure, everyone likes a bargain. It’s a nice feeling to walk out of a shop with a big saving. But don’t take this mindset to the stock market… a beaten-up stock may not be the bargain it seems — many get even cheaper. I believe a better strategy is to buy as prices rise. Trading with the trend is often the best deal in town.
So that’s all for this week. If you liked this video, or even if you didn’t, scroll down and leave me a comment, or maybe a thumbs up. Also, if you’re watching this anywhere other than my website motiontrader.com.au then head over and have a look.
So until next time, I’m Jason McIntosh, and let’s find some trends this week.
I'm Jason McIntosh, the creator of Motion Trader. My career began in 1991 on the trading floor at Bankers Trust. Nowadays, I trade my own systems from home in Sydney.
Motion Trader is for investors who value robust analysis, data driven entry and exit signals, commentary, and education. I use engineered algorithms to identify when to buy and sell ASX stocks. No biases or guesswork, just data driven signals.