All trades that I make are based on the concept of buying low and selling high, with varying details of complexity and strategies involved. Some traders don’t understand the basic principles of this strategy or how it can relate to the company. So here is an article covering it all.
The buy low, sell high market strategy is determined by supply and demand of a company’s shares. These factors will directly relate to a company increasing or decreasing its value due to its actions and ventures. You then determine where to enter (buy shares) and sell shares by implementing support and resistance factors, which you can visually track on a trading chart.
In this article, I cover how a company’s value is determined when going public. We then learn how its available shares are determined to go up or down in price by supply and demand and how supply and demand is affected by the company’s value. We look at precisely what supply and demand is. Then we take a look at support and resistance and understand what they are for us to buy low and sell high in the stock market.
Understanding a Company’s Value to the Stock Market
To buy low and sell high, we have to understand how a company initially enters the stock market and how the stock market affects the company’s value.
Market capitalization is the term used to refer to a company’s worth or “market cap.” The market cap is established in an event known as an initial public offering (IPO). This process details the company going to a 3rd party (investment bank) to use very complicated formulas to evaluate the company’s worth. They arrive at the market cap by multiplying the number of shares by the share price. They also determine how many shares are offered to the public and at what price.
After a company goes public, its shares will start trading on the stock exchange, and then its share price will be determined by supply and demand.
There are other ways to determine a company’s value, like intrinsic value, however the buy low sell high method is based solely on technical analysis of price movement.
Understanding Supply and Demand in the Stock Market
Supply and demand is a core strategy used when trading in the stock market and relates to stock prices in a free-flowing market and are fluid and vague concepts. We need a basic understanding of these terms to understand how they will affect support and resistance, and then, in turn, we can understand the buy low, sell high strategy.
Supply refers to a vague, sometimes unquantifiable economic concept that relates to shares in the market. When the market is flooded with supply (more shares available), the stock price for a company’s shares will go down.
Demand refers to the opposite of supply, where the unquantifiable commodity drives the stock price up, increasing its value. Less shares available to buy, drives the price up.
Relating Supply And Demand To A Company’s Value
Even though supply and demand are vague terms, they directly affect a company’s share price and market value. In essence, that is what you are doing when trading. You evaluate a company’s value and how that company will impact the market and economy with their product or service. Then you either decide to invest in that company or pull out of it.
Supply and demand could relate to many factors of a company. Perhaps the company makes agriculture equipment that cleans and irrigates sewerage water, and there is a draught that suddenly hits. The market value for the shares in that company will drastically increase, inflating the company’s value. Or perhaps a long-time CEO has been fired because of a scandal, and other investors and companies want to start distancing themselves from that company. That could cause the value of the company to go down.
Trading Volume is a good indicator of supply and demand levels, high trading volume means more demand.
Understanding Support And Resistance In The Stock Market
In essence, support represents a low-level stock price calculated over time and resistance is the opposite of that (it is a high-level stock price calculated over time). These levels usually can’t be surpassed. Let’s look at these two terms in detail.
Support in trading terms refers to a stock share price that a company rarely goes below. Another way to look at it is that it is a “floor” that the stock price rarely goes under and is held multiple times (the stock hits the floor and then bounces back up). Traders will plan and tend to enter the market at this point in a trade. Support and resistance can also be divided into a minor aspect and then a major aspect.
A major support level would be at a swing extreme (an extremely high or low point where the stock changes because of supply and demand). This is a key level that could be a daily low or monthly low, depending on what trading chart you are viewing.
Minor support is a level not quite as extreme and on a smaller scale, but where the support level is held and where the demand outstripped the supply, and there has been a turning point.
Resistance or resistance level is the term used to identify the ceiling point of a stock price. Resistance in effect contains the price, not allowing it to increase above this level. Resistance is unlike support, where the level needs to be held multiple times. Traders will tend to sell their stock here or employ other strategies (such as going “long”) to make their money.
As with major support, this is the extreme case of resistance where the stock price is well above its expected range and in turn, creates a swing extreme. Depending on what trade chart you view, this could be a daily high or monthly high.
This, as you guessed it, is the opposite of minor support, where a small ceiling is held over a period of time but where supply outstrips demand for a little while.
You can think of support and resistance concepts in terms of a see-saw where they go up and down depending on circumstances related to supply and demand. This happens because the stock is in a free-flowing fluid market.
These concepts may be challenging to grasp; however, another way to look at them would be; support and resistance is where the price of the stock was tested a few times, and it failed to break through (whether it was low or high) and it is where sell and buy orders are actioned.
Support And Resistance Zones
A stock price rarely ever sits at one price; for example, a stock might sit at levels of $99, $99.50, $100, or $100.50. Let’s consider this in our sample to be the support level. This means that the stock in this company has reached this level multiple times over a period of time and has never gone lower.
We can use these levels to make up a zone, and, in this case, it would be a support zone. This zone could then be thought of as a level of interest instead of a binary number, helping you with your overall thinking about what to do with the stock.
|Average Trading Price||Support Level||Resistance Level||Zone|
The sweet-spot for this stock is a $9 span, anything outside this level could lead to movements due to high or low demand for shares.
Defining what is High and Low in the Stock Market
Now that we understand supply and demand, support, and resistance, we need to break down and define what high and low are because it could mean different things depending on who you ask and what data you take into consideration.
We need the market to tell us what is low and what is high because you don’t want to buy a stock at a high price (that is what you want to sell it at), and conversely, you do not want to sell stock at a low price.
With the knowledge of support and resistance, we can now extrapolate with a degree of certainty what a low and a high is based on the market. Depending on what type of trade you are doing, you would have to calculate data over a certain period of time.
Hence a low would be the support floor that the stock does not break through, and a high would be the ceiling that the stock will generally not surpass.
The graph below will outline the support and resistance levels of a stock.
These levels are very linear, and easily defined. In some cases, we can look at support and resistance levels in an uptrend or downtrend:
By connecting the most recent resistance level with one previously marked, we can estimate not only the trend of the stock price, but where the next level of resistance will be. The same goes for support levels.
Relating the Buy Low, Sell High Strategy to a Company’s Value
If you are still not adept at understanding the market in terms of support and resistance, supply and demand, then another way to look at the market is through the company itself. What is the latest news about the company, and what can you expect it to be doing short and long term?
Understanding what a company’s plans and goals are will help you plot and understand the market value of it better. Many factors can contribute to a company’s market value, either falling or climbing, and you have to consider them all.
For example, if a company has a steady stock price, but they are about to announce something big (a new product or service). Then perhaps it would be an excellent time to get hold of some shares (buy low), then when the product is announced, and the stock price climbs, you would be able to sell it at a profit (sell high).
We conclude that to buy low and sell high, we need to understand the factors that affect the stock market, and we need to be able to read and anticipate the market with those factors. These factors come in the form of unquantifiable terms such as supply and demand, and these factors directly relate to the value of a company (how well or poorly it is doing).
Then we learned that we need the market to tell us what is high and what is low to buy and sell shares. These factors are termed support and resistance. These are visible floors and ceilings in the market chart, where the share price does not exceed or fall below a certain level.