Is there are right and wrong time to buy stocks? Well, that would depend on your investment strategy. If you are a trader then you may see nothing wrong with buying at a company’s highest share price whereas if you were a value investor you may be more cautious about buying at that same price.
These differing views can occur between different investors on the same stock and at the same price. So which one is correct? The answer is both are correct. The trader could trade out with small short term gains while the investor would be looking at a long term position and may consider the current market cap too high due to the unforeseen rapid increase in stock price.
So when are you supposed to buy shares? Here is a risk analysis of different entry points and also some of my tips on purchasing so that you well educated before you make your decision:
My 5 Rules for Buying Shares
Here are my 5 stock picking rules that I run through before I purchase any stock. These are not all of the factors that I use but they are nevertheless a good starting point:
Purchase on Current Facts Not Future Revenue – A company may have exciting prospects and good future potential but, in my opinion, it would be wrong to invest solely for that reason. Prices fluctuate and you always have to be careful that you are not investing today at price that reflects the “potential” value of the company in a few years time. I have seen this type of scenario occur frequently in the mining sector where a company’s price will shoot up to reflect an oil find yet investors forget that there are still further costs and risks associated with extraction and production.
Buy When The Company Is Undervalued – I will usually be watching a few companies at the same and it is important that the company I choose to invest in is the most undervalued of those companies and also undervalued in relation to it’s peers in the same sector. It’s important to wait for a good price and not to buy when the overall market is too bullish.
Beware of Number of Shares in Issue – From my experience, you should always tread carefully with a junior company with a lot of shares in issue. It usually means something has gone wrong recently and they’ve had to issue more shares – this could be due to a number of reasons but all of them are bad. I avoid companies which are going to be short of funds in the near term because another share issue and more dilution will be likely.
Invest in an Experienced Management – Don’t give your money to a senior management team with a lack of experience and poor track record. It’s very important to do some due diligence on the management team and this information can be found on their website, by typing their names into your preferred search engine and also inside your broker research tools.
Do You Understand The Business Model? – I tend to only invest in companies that I can understand. The process in which they generate income and their products / services must be easily understandable and clear. I try not to invest in overly complex companies because it makes following progress much more difficult which presents risks. As Warren Buffet once said “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”.
When NOT To Buy Shares in a Company (Beware of These Risks)
When everyone else is buying – Warren Buffet once said “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”. When everyone is talking about a stock to buy, it is usually already too late. If a large number of people have purchase stock in the same company before you the price will already be inflated. Never follow share tips blindly as they often end in disaster. It’s always best to do your own research before making a purchase.
When the market cap is too high – Market capitalisation tells us the price the market values the company at. Beware of high market caps, especially in junior companies as it can be a sign that it has been overbought. A high market cap should always be supported by the value of assets, current revenue and profit among other fundamentals.
When you can’t afford it -This one should be obvious but I’ve lost count of the horror stories I’ve read about people becoming bankrupt from investing in shares. You should only invest with what you can afford to lose, do not pour your whole life savings into the stock market, especially if you are still a beginner, and do not take out loans to buy the “flavour of the month” oil company.
The Risks of Buying at the Top
Should you buy when the share price is at a high? If company A was priced at 10p per share and it was at it’s 52 week high, would you avoid it? The highs and lows of stocks can be a useful indication for entry points but unfortunately they only tell half of the story. The other half is the fundamentals. Perhaps something important happened in the last month which made the share price tumble, making it only worth half of what it was before. For example, if Company A was a copper miner and they had to stop mining at one of their mines due to the price of copper. Here is an example of a graph where a a top has been identified:
Share price performance and highlighted high point in African Eagle Resources
Would you buy at the point highlighted above? There’s a number of reasons why that would probably not have been a good entry point i.e. huge leap in share price on the way to 16p, historical resistance point and poor fundamentals (high market cap and the price shot up due to a farm in deal announcement), high risk and limited reward at that point of the company’s lifecycle and news flow. All of these factors together made any further increases in share price unlikely and unsustainable.
The Risks of Buying at the Bottom
What would you consider to be a low share price? When the price hits a 52 week low? A 1 year low? Or maybe the lowest price is the 5 year low? Different time frames make picking the bottom of a share price very tricky and although buying at any one of those points may give the highest risk to reward, you may also inadvertently find yourself buying a company on it’s way to bankruptcy.
Buying at the bottom is not as easy as it sounds and you should not buy at lows when the company in question is on it last legs (i.e. out of money and ideas). In particular, beware of small companies in trouble as it is likely they will lack the management expertise, experience and funds to get out of trouble.
I prefer not to buy the lows of a long term down trending company and would much rather go with a company at a low but with a clearly defined short term range such as the one shown below:
Is there a right time to buy? Well, on the evidence provided in this article I think we can agree that there are several ways we can reduce the risk and maximise reward by choosing our entry points carefully. Remember, you don’t have to time things perfectly in the stock market – you just have to be around the right area and patient enough to hold.