In the previous two articles (here and here), we explored the topic of "which stocks to buy." This helped us create a list of stocks worth investing in. In this article, we'll look at the question "when to buy a stock?"

Detecting Stock Price Lows

The short answer to the "when to buy" question is, of course, "buy low." The difficulty is in knowing when the stock price reaches its lowest value. There are a lot of algorithms (formulae) that try to predict an oncoming stock price low, with varying degrees of accuracy. The results are not guaranteed — they all have probabilities of errors.

Instead, we take a conservative approach to determining when a stock has hit its 'low' price. Like everything in stock investing, this not an exact science. We'll describe a way to observe the stock price over several days to detect when it has just reached a low value. (As past performance does not imply similar future performance, this is just yet another data point in our stock-buying process.)

Stock Price Up-trend

We observe the ups and downs of a stock price for a while to understand whether there is a value X such that, most of the times when the price dropped and then rose by X%, the price continued to rise further. And, whether most of the times it rose by less than X%, it did not rise further (it was just a blip). This value X is our 'buy threshold' value — we learned about 'buy threshold' and how to select an appropriate value when we were discussing stock trading simulation in the previous article.

Note that the 'buy threshold' value may be different for each stock, since no two stocks behave the same way. And, it takes some trial and error to arrive at this value. Furthermore, as the underlying company's business and revenue changes and the stock price trend reflects these changes, the 'buy threshold' value will also require fine-tuning. (We'll explore fine-tuning in a subsequent article.)

Choosing the right value for the 'buy threshold' parameter is important: with too high a value, we buy late and miss out on some of the gains; with too low a value, we buy too early (during a blip) and the stock price drops again.

Buy On the Rise

Another good reason to buy a stock only when its price is trending up is that not doing so almost guarantees a loss. The last thing we want is to buy a stock and the stock price falls immediately afterwards. Thus, even when we use the 'passive' ('buy and hold') strategy for a specific stock and are OK with riding out any ups and downs of the stock price, we still want to start investing in the stock only when the stock price reaches its 'buy threshold' and is trending up.

Summary

It is important to buy a stock only when we believe there is a good chance for the stock price to go up further. We want to wait until we're somewhat confident of that happening, before we invest in the stock. Using the 'buy threshold' is one way to do that.