Marketing timing strategies like “buy low, sell high” make sense of past market movements, but are pretty much useless at predicting the future.
Most investors are familiar with the term, buy low, sell high. It sounds great, you buy stocks when their prices are low, then you sell them when they become high. The main problem, of course, with this market timing theory is that it’s hard to predict when the price of stock will be at its lowest or highest. The buy low, sell high theory also has a physics counterpart, and it’s called the “pendulum theory”.
The “pendulum theory” grew out of Sir Isaac Newton’s 17th-century studies of gravity and physics, particularly his second law of motion. Yet the theory turns up in discussions of all sorts of non-mechanical topics. It’s even become part of investing advice.
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You could sum up the investment version of the theory like this: stock prices alternate between periods of overvaluation and undervaluation; the degree and duration of each period of overvaluation is related to the degree and duration of the subsequent period of undervaluation, and vice versa.
In other words, the theory says that when stocks head downward after a period of overvaluation, they won’t stop at fair value. Instead, they’ll keep dropping until they hit lows that are in some sense as out-of-whack as previous highs, or close to it.
Pendulum theory explains the past, not the future
Pendulum theory is a handy way to label the past, and it gives you a sense of how stock prices behave. But it’s useless for predicting the future or timing the market. That’s why it generally plays a small part in successful investing.
If you qualify as a “successful investor,” you probably recognize that the market never gets so high that it can’t go higher, nor so low that it can’t drop some more. This is a key part of understanding the stock market.
Today’s top pessimists lean on the pendulum theory, they also harp on their own version of buy low, sell high. They couple this with a narrow selection of downbeat statistics to support their views, and it all seems very grim. At the Successful Investor, we advise our clients to examine the market and its securities with healthy dose of skepticism, not pessimism.
Note: This article was originally published in May 2012 and has been updated.
