Buying at the Right Price Increases Your Chance of Making Money

Buy low and sell high is a sure bet for profitable investing. But the trick is to identify a low buy price. Paying $3 for a stock that ultimately goes to $3.15 is not buying low. But paying $3 for a stock that goes to $20 is buying low. The key question for the investor becomes: What is the chance that I will make money if I buy a stock at a given price? Intuitively you know that if you buy at "low" prices, the chance of making money will be high. But as prices increases, the chance of making money will decrease.

This article describes a procedure called the Chance of Making Money Model (C3M) that quantifies the chance of making money for different buy prices for stocks with cyclical price patterns. With C3M you are able to make the following type of precise statement: "If I buy the stock between $4 and $6, the chance of making money is 85.5%."

Use Past Cyclical Price Patterns as a Window into the Future

No one knows for certain what stock prices will do in the future. But if you believe that future price cycles will have characteristics similar to past cycles, you can use historical price data to make inferences about future buy and sell combinations. Examining past price patterns of cyclical stocks like semiconductors and semiconductor equipment makers let you quantify the chance of making money for different purchase prices. These stocks have repeating cyclical patterns characterized by an initial low, upside of rising prices, peak, downside of declining prices and a final low. This recurring cyclical pattern enables you to analyze the chance of making money for given buy prices because the same prices occur cycle after cycle. For example a $5 price can occur many times on the upsides and downsides of a multi-year, multi-cycle price series.

How the C3M Works

C3M computes the frequency of profitable buy and sell combinations (trades) for selected buy prices for a selected stock. You input a price series (daily, weekly or monthly closes) plus the selected buy price range to C3M and it computes the percent return of every buy and sell combination for the buy prices using the same methodology employed by the Complete Trading Model (CTM).

Then C3M counts the number of profitable buy and sell combinations and finally C3M computes the frequency of winning trades by dividing the total number of profitable trades by the total number of trades. The frequency of winners becomes the measure that you use to estimate your chance of making money for a given range of buy prices.

The chance of making money estimates are derived from the KLIC daily prices that includes five distinct price cycles.

The table and the chart of the table values shows the rapid decline in the chance to make money as the buy price increases.

The data clearly show that buying at $6 or less gives you a 90% chance of making money. The chance of making money drops rapidly for buy prices higher than $8. As price gets higher and higher, the chance of making money drops rapidly and moves toward single digits.

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