By Ee Hsin Kok. Edited by Arjun Chandrasekar.
Assuming you’ve found a company that you believe to be fundamentally good and want to invest in, the next question you’re likely to ask yourself is when to buy that company’s stock. That’s what we’ll be covering in this article.
Buy it When it’s Fairly or Undervalued
The first (and arguably most important) criteria when purchasing a stock, is to buy it when it is fairly/undervalued. A good company is not always a good investment IF you pay too high of a price for it. Therefore, aim to buy a stock only when it is near its fair value (or below). Be careful not to chase overvalued companies who are still rapidly increasing in price. This happens quite often and it may be tempting due to a Fear Of Missing Out, but remember prices don’t move in straight lines. Even the best companies in the world go through massive drawdowns where they will retrace to their fair value, or even far beneath it.
Buy it in Stages
The second step is to buy into stock in different stages. What this means is that if you have allocated $10,000 for a stock, you do not want to buy it all at once. You could first buy $5000 worth of the stock, and if it falls even more, buy another $5000. This way, you have the opportunity to average down and get a better price should the price keep falling. Do keep in mind that this applies in most general situations. If a stock has already fallen and is massively undervalued (30% or more below fair value), it can make sense to buy all $10,000 at once. Since if you had discovered the company earlier and watched it fall, you would have been buying throughout the fall and would have spent $10,000 throughout the fall.
Buy When it Retraces to a “Support” Level
This third step is not as crucial as the first two, but it can be pretty useful. This compliments the second step by giving investors clear levels where they should buy a stock. Now it should be noted that many successful investors, such as Warren Buffet, do not use this approach. Warren Buffet is famous for his critique of technical analysis, and he has had a pretty successful career. But that doesn’t mean you shouldn’t use it either. It can be a useful tool in managing your buy points. Support levels can be historical horizontal support levels, trendline support levels, or moving averages that prices previously bounced off from. For example, in the chart below, the support level is a trend line we drew. When prices get near that point, it becomes a great time to buy shares.
In conclusion, there are three main questions you should ask yourself when deciding if it’s a good time to buy a stock.
- Is the stock undervalued?
- How much should I buy right now?
- Is the stock at a support level?
Based on your answers to these 3 questions, you can make educated decisions on when to purchase a stock!