EVERYONE knows that the key to a profitable investment strategy is to buy at a low price and sell at a higher one.

Of course, in practice, things aren’t quite that simple. For one thing “cheap” investments can become even cheaper. In addition, unless you have perfect 20/20 future vision (and please give me a call if you do), it is impossible to predict with absolute certainty which way prices will move in the future, and by implication if the stock market is really close to bottoming out. The irrational behaviour of investors also inhibits the success of a buy low/sell high strategy.

The study of such irrational behaviour, known as behavioural finance, is both a complex and a fascinating branch of investment theory. It tries to explain why investors take the decisions they do, and how their actions can be influenced by others during the decision making process.

The theory goes that if investors can recognise their inherent psychological flaws, irrational behaviour could be avoided, thereby improving investment returns.

Many books have been written on the subject of irrational behaviour, and one of my favourites is Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds, written in the 1840s.

Mackay highlights how stock markets are particularly susceptible to manias, panics and crashes as prices can be driven to extraordinary heights by irrational behaviour, only for confidence and greed to turn quickly into fear and despair, sending prices into freefall. Sound familiar? One commonly recognised psychological flaw discussed by Mackay is the herd-like mentality of investors to follow the consensus view which normally results in investors buying high and selling low, rather than viceversa.

This is because investors are always more comfortable investing when the economy is buoyant, company results are strong and there is generally a feeling of economic wellbeing in the air.

Unfortunately, when these conditions prevail, share prices have already anticipated and recovered to reflect the good news, and the best potential gains are missed. Greed prevails, as more and more investors enter the market on fears of missing out. Those already in the market also get swept up by the wave of euphoria and resist the temptation to take profits as share prices move ever higher. When markets rise too far, too fast, trouble is normally just around the corner.

Similarly, there is a natural tendency for investors to sell shares (or avoid buying them) when market conditions are terrible and share prices are trading at multiple year lows. During these times of financial armageddon, company profit warnings are rife, economic news just seems to get worse and worse and only the brave dare talk about potential green shoots of recovery.

After all, who in their right mind would want to invest into shares that are constantly falling?

Just over 12 months ago, the UK stock market, as represented by the FTSE 100 Index, was trading about the 6500 level. Only four weeks ago, the market hit 3500 on panic selling, but then bounced sharply to about the 4100 level. Those investors who ignored their irrational urges and bought shares at low prices in battered “cyclical”

companies such as banks, retailers, house builders and miners have been richly rewarded, with some almost doubling in the space of a few weeks. With the market retreating below 4000 again as I write, those who missed out on the sharp rally may soon get another chance to enter the market at historically low levels.

• Mark McMullan, above, is an assistant director in the Teesside office of Brewin Dolphin, and can be contacted on 0845-213-1340.

Views expressed are the author’s own and are not necessarily held throughout the Brewin Dolphin Group.

Brewin Dolphin Ltd, a member of the London Stock Exchange, is authorised and regulated by the Financial Services Authority.