The Great Paradox in Stocks

[The following is from p.174-176 of How to Make Money in Stocks (4th Edition) by Williams O'Neil (2011). McGraw-Hill.]

The staggering majority of individual investors, whether new or experienced, take delightful comfort in buying stocks that are down substantially from their peaks, thinking that they are getting a bargain. Among the hundreds of thousands of individual investors attending my investment lectures in the 1970s, 1980s, 1990s and 2000s, many said they do not buy stocks that are making new highs in price.

The bias is not limited to individual investors, however. I have provided extensive historical precedent research for more than 600 major institutional investors, and I have found a number of them are also “bottom buyers.” They, too, feel it’s safer to buy stocks that look like bargains because they're either down a lot in price or actually selling near their lows.

Our study of the greatest stock market winners proved that the old adage “buy low, sell high” was completely wrong. In fact, out study proved the exact opposite. The hard-to-believe Great Paradox in the stock market is:

What seems too high in price and risky to the majority usually goes higher eventually, and what seems low and cheap usually goes lower.

Are you finding this “high-altitude paradox” a little difficult to act upon? Let me cite another study we conducted. In this one, we analyzed two groups of stocks – those that made new-highs and those that made new-lows – over many bull market periods. The results were conclusive: stocks on the new-high list tended to go higher in price, while those on the new-low list tended to go lower.

Based on our research, a stock on Investor’s Business Daily’s “new price low” list tends to be a pretty poor prospect and should be avoided. In fact, decisive investors should sell such stocks long before they ever get near the new-low list. A stocks making the new-high list – especially one making the list for the first time while trading on big volume during a bull market – might be a prospect with big potential.