Buying the Low’s

On Twitter, Alokesh Phukan asked me a query on the difference in returns between buying at the high of the year every year vs buying at the low of the year .

Not sure if this study holds for our volatile mkts @Prashanth_Krish can find out l guess;) #PeterLynch #MarketTiming pic.twitter.com/tGr1Cs8rCi

— Alokesh Phukan (@greyfool) March 16, 2016

Now, who would not want to buy at the lows of the year but the sad truth is that we have a higher probability of getting hit by lightning than being able to buy at the low of the year, year after year for decades together. And all this for what?

The difference (XIRR returns) comes to 3.12% and while its big, do note that we are comparing against another operator which is non predictable. The easy thing to do would be to buy at the end of the year and the difference between the low and the close comes to just 1.83%.

Since objections were raised as to how every one percent additional returns can make a huge difference at the end, let me provide the figures.

Assuming one invests 1000 Rupees every year, the returns at end of 26 years (Investment of 26,000 Rupees) would be

Value if bought at Low: 2,01,739.00

Value if bought at High: 1,21,043.00

Value if bought at Close: 1,49,321.00

Given that there is no way we could have bought the low (buying the high is much more possible given our emotional state when everything looks good), the question is whether there is anything we can do to minimize the difference between buying at the low and buying at close.

If one wants to trade only once a year, there doesn’t exist much scope other than maybe split uniformly across the year and hope that the average is lower than the year-end closing. But if you are game to trading, there does exist a method where we could actually end up buying more cheaply than the Index (or Stock) was available to trade.

Trading Systems exist by the thousands though the few that are able to beat indices consistently would not be publicly available for trade. Any trading system that has positive expectancy is something that is worthwhile to bet on (if other tests prove it to be a able commander of money).

In simple words, Positive Expectancy is the points your system can make overall per trade (average). If your system trades say 1 trade a week (52 trades a month) and makes on a average 20 points per trade, at the end of the year, the average price of your stock would be (assuming you buy to hold at end of the year) Close Price – (20 * 52) = Close – 1040.

Of course, let me add that you cannot possibly hope to make 20 points in stocks such as ITC, but is entirely possible in Indices such as Nifty 50 or Nifty Bank. Another caveat is that there is no certainty that you shall have your 20 points year after year. Some years will be better than 20, some worse. But if that 20 holds on in the long term, you could actually have a negative price as your purchase price some years down the lane, something that is impossible if you just buy and hold.

Trading means more efforts (both in building systems as well as executing the trades) plus more in commissions / taxes. But if end of the day, you are liable to make a much larger gain without it being relative to how the market performs, its a fair deal in my opinion.

You will never be able to make that one good trade every year, but the law of large numbers will ensure that if your system is good, you could get a return way higher than what you could get by having a crystal ball provide you with the exact date and price of the low for the year.