Buy Low Sell High – Margin of Safety

Market timing is a keyword which finance experts write books on. They try to make it complicated, introducing formulas and requirements for input data before you can come up with a scientific and logical answer to a simple question – How do you know when to buy and when to sell stocks? After all, a simple way to make a buck is to buy something for a dollar and sell it for two. So the goal is buy low and sell high.

Is there any way to make sure that you can sell high, and not be wiped out? While there’s no such thing as a risk-free stock, there is a concept known as a ‘margin of safety’. This concept was pioneered by Benjamin Graham, often known as the father of value investing. One of his famous acolytes, who has put into practice Graham’s teachings, is Warren Buffet, whose 50 billion Berkshire Hathaway Inc. is a living testament to the success of these techniques.

The way it works is pretty simple. First, you accept the notion that every stock issuing company has a certain baseline market value or true worth, and any deviations above or below are just that – Deviations. That means these deviations are bound to be corrected sooner or later, and will head back in the direction of the true worth. All you need to do is have in your hand the company’s true worth and a margin of safety marked above and below the true worth. If a company slips below the margin of safety, you buy it. Once it climbs over the margin of safety, you sell it.

It goes without saying that the success of this strategy vastly depends on the accuracy of your take on the precise market value of the stock, or its true worth. So how exactly are you supposed to calculate the true worth of a company’s stock? Value investors often use discounted cash flow calculators, which spit out a company’s current worth if you input in the company’s expected annual cash generation in the coming years.

Please note that investors like Warren Buffet have spent lifetimes fine-tuning their buy-sell strategies, and you are advised to consult your financial planner before you make any investments. There are lots of other things about the financial markets which impact investment decisions including expenses and regulations, and which you are likely to find out only by experience, or from a financial advisor.