Why New Highs Shouldn't Stop You From Buying

I get a lot of eye rolls when folks ask me for investment advice...

My typical quip is: "Buy low and sell high." People can never tell if I'm being serious.

While my "advice" is more glib than helpful, it's undeniably true. Every investment textbook spends chapters trying to say just that. (When someone wants to talk to me long enough, I do give them a more detailed answer.)

But buying low and selling high isn't the only way to make money.

Today, I want you to flip that universally accepted philosophy around.

I want you to adopt the mindset of buying high...

Now, this can sound daunting... maybe even crazy. Most folks get queasy when they buy a stock that's at or near an all-time high. They think they've already missed their chance to profit... and that anyone still buying is a fool who's about to get burned.

It's an understandable mindset. But it's wrong.

If you're a regular DailyWealth reader, you won't be surprised to hear that stocks approaching 52-week highs often outperform stocks chosen through other strategies...

Several academic papers have looked at decades of data to support this theory. One research paper by Thomas J. George and Chuan-Yang Hwang titled "The 52-Week High and Momentum Investing" showed that the closer a stock's current price is to its 52-week high, the stronger it performs in the future.

The question most people find themselves asking is: How can stocks that are near highs still be undervalued?

The answer involves the mental mistake commonly called the "anchoring bias." Daniel Kahneman – the only psychologist to win a Nobel Prize in economics – first coined the term for this phenomenon.

When you provide folks with an initial price or number, it skews their thinking. They "anchor" to the old info.

Here's a classic example of the bias from a 1974 experiment run by Kahneman and Amos Tversky...

Participants of the study had to spin a "wheel of fortune" to get a random number. Half of the folks ended up with the number 10. The other half got 65.

The participants were then asked whether the percentage of African countries in the United Nations was greater or less than their number from the wheel of fortune. Folks who got the number 10 estimated 25%. Folks who got 65 estimated 45%.

The "anchor" numbers biased the participants. People made lower guesses after the initial low anchor than they did after the high anchor.

There are countless examples like this from all different kinds of studies. We also see the anchoring bias in effect every day in marketing and negotiation. The first number or price you hear is the one you anchor to – even when that information is irrelevant on its face.

This happens in the stock market every day, too. Specifically, investors tend to anchor to a stock's high share price.

It's easy to find whether a stock is at its 52-week or all-time high. So that's what investors anchor to.

If a stock is down 20% from its high, that tells some folks it's a good value. Meanwhile, if the stock is trading at its high, they expect it to head lower.

You have to set aside your emotional reaction to a stock trading near its highs. There are better ways to determine its real value...

I always start thinking about a stock by remembering it's a real business. If you buy great businesses at good prices, you'll win over the long term.

And, of course, a company's share price by itself tells you nothing about the company's actual valuation. For instance, if a company's revenues and profits have grown to all-time highs, why wouldn't its stock price follow suit?

Many stocks hit new highs because their companies are doing something right. If they keep doing those things, prices can keep rising.

So don't get hung up on a 52-week high. A stock's previous price doesn't tell us where it's going next. When the valuation is still compelling, disregard my old quip and buy high.

That's why when someone asks me when to start investing, I say it's always a good time to invest. Even when markets are volatile, you can find plenty of opportunities.

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig

Editor's note: One group of stocks has skyrocketed this year... and that's the artificial intelligence ("AI") sector. But don't assume the big gains are over. One of the best ways to make outsized profits is to find the best-positioned players in the early stages of a once-in-a-generation trend.

Even better, while pundits squabble about where AI is headed next, thousands of people are already taking advantage of one of the biggest potential developments for investors. That's why our company aired a deep dive on AI this week – with a special guest appearance – to help you cut through the hype. If you missed the discussion, check it out right here.

Further Reading

"People can easily be paralyzed by indecision," Doc explains. Investors can get lost in a sea of ratios and statistics. But don't spend so much time on research that you forget to act. Here's how to focus on what matters most... Read more here.

"The trend has been up for most of the year," Brett Eversole writes. Stocks have "officially" entered a new bull market. In the past, similar rallies have led to new highs. And history shows we should expect outsized gains over the next year... Learn more here.