Buy low, sell high to make money in stocks

I believe there is only one way to make money in the market. That is 'buy low and sell high'.

Sounds simple, doesn't it? But the execution is not very easy. However, if you are disciplined and patient you can master this art and make money.

After a lot of experiment I have found one strategy that works.

There are 4 rules you need to adhere, though, come what may, to achieve success using this plan:

~ Decide the quantum of investment you will make on every fall (say Rs 5,000)

~ Buy units/shares on any day when the market comes down by more than four per cent

~ Sell the same amount of units/shares that you would buy when the market goes up by more than five per cent on a given day

~ And, of course, keep doing it regularly

Now don't take my word for it. For all you want let's validate this data on the Sensex and let's do it for a very long period of time, say from 1980.

The trick here is you will buy shares/units worth Rs 5,000 on every buy opportunity and sell shares/units worth Rs 5,000 on every sell opportunity as per the rules decided above.

On June 6, 1980, the Sensex was at 122.55 levels (for simplicity let's assume that one unit of Sensex could be bought as a share/unit at Rs 122.55). On this day the Sensex had come down by more than four percent. Let's consider the closing prices as your buy price; therefore you could purchase 40.8 units of the Sensex with Rs 5,000 (Rs 5,000/122.55 = 40.8).

Similarly, when on August 5, 1980 when the Sensex reached 135.5 levels (a gain of more than 5 per cent on that day), you could have sold 36.89 shares/units worth Rs 5,000. This will leave you with nearly four units (3.91 to be precise – 40.8 less 36.89) of the Sensex and that too free of cost. In money terms, your gain would have been Rs 527.91 (Rs 135.52*3.9 units).

Now you need to keep in mind that there could be more than one buying opportunity in a year. This is what happened in the year 1981. You had two days when our rule told us to buy (ie a fall of more than four per cent on a single trading day). On May 4, 1981 and on July 17, 1981 the Sensex fell by 4.17 per cent and 4.36 per cent respectively. Therefore we bought the Sensex at Rs 178.5 and Rs 197.1. The average price at which we bought the Sensex was Rs 187.8 and we made a purchase of (28+25= 53 units).

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Remember that in 1981 you would have got a chance to buy into Sensex on two occasions and hence you would have invested Rs 10,000. However, the Sensex rose only once by more than five per cent so you got only one opportunity to sell your shares/units.

Remember that in the same year you got only one opportunity to make a sale (ie an intraday increase of more then five per cent) and the closing price for that day was 208.2. As per the rule you will sell shares/units worth Rs 5000 (ie 24.02 units) only.

Now your net cash outflow is Rs 5,000 and you have accumulated 33 units (4 units in 1980 and 29.36 units in 1981) of the Sensex. The average price of the Sensex for the year of 1981 was Rs 209. Therefore the value of your units was Rs 6,925. This means you made a profit on 38.5 per cent (6,000 less 5,000 divided by 5,000 and multiplied by 100) on your investment which came in only about 6 months before the end of the year.

Similarly we repeat the process for all the years up to January 2008. In the table below (detailed analysis of the strategy) I have calculated the shares/units you would buy and the average price at which you would buy them. This is done by averaging the number of times the buy or sell signal is given in that particular year.

Remember this before you read the table

~ The years 1983, 1984, 1995, 1996, 2002, 2003, and 2008 (till mid January) gave you no buying or selling opportunities as the Sensex did not decrease or increase as per our rules.

~ The years 1988 and 1996 gave only selling opportunities.

~ The value of accumulated units would increase or decrease as per the corresponding change in the Sensex level at the end of that particular year.

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~ Net cash flows in black indicate you bought and sold units/shares worth the amount decided earlier, that is, Rs 5,000. This shows that you got only one buying and one selling opportunity in that year.

~ Net cash flows in brackets indicate that you got more than one buying opportunity, that is, the Sensex dropped by more than four per cent more than once, but gained more than five per cent only once on a given single day.

The net cash flow for 15 years is negative in the last 28 years. This means that you have bought in excess of what you sold in all these years. Over all in 28 years there would have been 92 occasions when you could have bought and about 54 occasions when you could have sold.

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The value of the units that you would have accumulated would have been worth Rs 32 lakhs on an investment of just Rs 1.92 lakhs! And remember you have not put the money at one go or even in a single year. The investment has been spread across 28 years. That makes it an investment worth Rs 6,874 per year or Rs. 572 per month! Just like your mutual fund systematic investment plan.

Now let's see what happens if you would just do one part of the strategy: that is, investing a fixed amount whenever the markets fell by more than four per cent and never bothered to sell the units when the markets rose by five per cent as per our rules. In this case you would have had 785 units (ie Rs 1.6 crore) on an investment of Rs 9.2 lakhs.

To successfully execute this strategy you would require a very high level of discipline and courage which is rare in the investment world and the risk return ratio would be the same. Investment using this method can generate very good returns over a period of time and would not even block a lot of your money.

Disclaimer: The views expressed by the author are personal and not that of Rediff.com. Rediff.com has not altered the material presented here and does not endorse it in any way.