Saturday, April 26, 2008

Market Cliches

When I first was drawn to trading I was a little intimidated by parts of the new language (e.g. diagonalized calendar spread or strangles or going naked) and I was a little amused by some of the cliches. Sayings like "you can't go broke making a profit," or "the trend is your friend" easily reinforced some conventional wisdom with something I could easily remember. Some of these sayings have become so well known that I have wondered how often and in what ways they may be applied. Are they 'truths' of the market? Are they infallible? Is there some other side? Do they really work? I'm going to take a look at a couple of these cliches in this article and give you my own thoughts. Mostly, these are just my opinions and I would encourage you to form your own. Just doing a little thinking about the meaning of some of the cliches might give us some new insight.

The first saying that might be worth looking at is the idea that "buy and hold" is the best (and as at least one subscriber noted) and perhaps the only way to succeed in the markets. I devoted a little space in my book, "Trade Your Way to Wealth," to an analysis of "buy and hold," and, suffice it to say I don't see how the strategy "buy and hold" answers the question: "Hold 'til when?" " Buy and hold" is a strategy based on the historical fact that markets go up over time and if one holds a position in a stock, it is probably going to increase in value over time. Depending on the specific stock and depending on the time frame, that may or may not be true. What the strategy really lacks, in my view, is an exit. Is the exit "buy and hold" hold until death? What else is it? When do you get out of a losing position if your strategy is to buy and hold? How does that thought correlate with the next important cliche: "Cut your losses and let your profits run."

It seems to me that if you are going to buy and hold (does that mean buy to hold?) you have no way of cutting your losses. Though your profits may run, they may also disappear, and even turn to losses if there is no exit strategy. I personally am a believer in cutting losses and letting profits run. Hardly anyone would disagree with the general principles in that cliche. The problem I have seen is that so many retail traders don't have a clue how to cut losses or how to let profits run. It does suggest the need for some plan on the trader's part that will define when, or under what circumstances, the trade will be closed. There are many ways that creating an exit strategy can be accomplished and it is up to the individual to chose the strategy that best fits his own trading needs and personality. One trader may decide to use a cross above a moving average as a reason to enter and a cross beneath the average to be a reason to exit thereby making the moving average the strategy. Would that help cut losses? Sure it would in most cases. That strategy could also let profits run because there would be no exit unless and until the stock price dropped down through the moving average. A different trader may choose to move stops behind his position either on a trailing basis or at a specific stop price that he could regularly move behind his position. I discuss this concept in "Trade Your Way to Wealth" and believe it is an important concept for every trader to incorporate into his personal trading plan. I don't mean to suggest any specific exit strategy is better than some other one, but I do mean to suggest that I think is better to have some disciplined exit strategy in place than to have none at all.

I hope that is food for a little thought. Down the road, I think I'd like to take a look at "buy on the rumor and sell on the news" and maybe "you can't go broke making a profit." Maybe even think about "the trend is your friend" or "you earn on the turn". Let me know if you are aware of some market saying that we might have some fun thinking about.

by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved


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20 comments:

Anonymous said...

How about "Bulls make money, Bears make money, but Pigs get slaughtered". - diceyliving

Gary E. from WI said...

I've never commented to you before, but I thoroughly love all your articles and look forward to reading them each weekend.

I totally agree with your assessment of 'buy and hold'. You must have an exit strategy as well as an entry trigger.

Please discuss 'the trend is your friend'. Is this a self-fulfilling prophecy? Are all the common sayings self-fulfilling? I don't think they are because they fail too many times.

Also discuss the cliche 'cut your losses, let profits run'. I think this is integral to any strategy a person may use.

sam in las vegas said...

Hi, Great reading each weekend. Warren Buffet I am told bought Coke a cola years ago. Splits and reinvested dividends take care of this stock.
I am older and need stops on all of my trades
Keep up the great work, Sam

Anonymous said...

I agree with your artical 100%. I belong to an investment club with 20 members. The club is characteried as a "buy and hold" investing group. We haven't made any money in 5 years. Most members believe in the b&h philosophy but havent a clue about taking a profit or setting up a plan to cut losses. Actually, we pretty much "MARRY" our stocks. In the 5 years we only sold about 4 holdings because we had a good profit. We probably sat on about 40 holdings because we love the stock. We only look at the bright bit of good news and turn a blind eye toward mounds of bad news.
I think many feel that trading is a bad word and do not want to be associated with the stigma. Thus we are investors and we hold for the long term, which gets longer at each monthly meeting.

Patrick said...

So many people seem to not have an understanding of "buy and hold". First, you must be a good appraiser and buy companies which have good management and are undervalued. You buy these companies as if you plan to own them for 20 years. You hold them until their stock price has risen to, or exceeded, their intrinsic value, or until any assumptions you made in valuing the company prove to be in error. This might be a year, or it might be 25 years. That's why it is called "buy and hold". If you let your emotions rule you and decide to sell as soon as you see a 30%-50% price drop in a stock you own which you do not think has risen to meet its intrinsic value, then you need to stay out of the game. Even Berkshire Hathaway lost 50% of its value one year. It came back and far exceeded the previous levels, however.

Anonymous said...

The "buy and hold until when?" question is fairly easy to answer. When buying a position for what you intend to be a "buy and hold" position, you first buy a quality stock and then you hold until there is a negative change to the fundamentals of the company. That is, your reason for holding the quality stock has diminished or evaporated entirely.

Bill Kraft, MarketFN.com said...

Diceyliving, that may be the most important one of all. We can profit playing the market in either direction, but when we let greed take over, we generally get flattened.
Bill Kraft

Bill Kraft, MarketFN.com said...

Glad you are enjoying the articles, Gary. I'll try to cover a lot of these cliches as time goes by. I'm always interested in readers thoughts.
Bill Kraft

Bill Kraft, MarketFN.com said...

Sam, that's what I've heard about Mr. Buffett, too. No question buy and hold can be a successful strategy if we have the time to hold and don't care what the 'ups and downs' are in the meantime. I'm like you. I always have an exit strategy. I don't think Mr. Buffett needs one anymore; I guess he was just a lot smarter a lot earlier than I.
Bill Kraft

Bill Kraft, MarketFN.com said...

Anonymous, I think the philosophy of your investment is pretty common to a lot of retail investors as well. Does your club have any exit strategy at the time it enters a position? It might be fun to ask that question before the next buy to see what you stir up. I can see the reasons for some of the bad impressions of day trading, but I think people shy away from short term or swing trading because they don't really understand how to go about it.
Bill Kraft

Bill Kraft, MarketFN.com said...

Patrick, thanks for a great comment. You have defined what "hold" means to you in "buy and hold" and have thereby set out your exit strategy when the stock goes up. What is the strategy when it goes down? You mentioned a 50% dip in Berkshire Hathaway from which there was a recovery. What about stocks like Enron, or some of the bankrupt airlines, or WorldCom where investors lost everything? Is that an acceptable result? It may be if the investor makes more overall than he loses on the ones that disappear. We should always remember that if a stock loses 50% of its value, it must move up 100% just to get to even and, Berkshire Hathaway aside, not too many achieve that goal.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks, Anonymous, for your definition of "hold until when." It differs somewhat from Patrick's definition, but, quite interestingly, you each rely on a fundamental change as the exit strategy for "buy and hold" investors. In Patrick's scenario, I see no definition of when the "buy and hold investor" would have exited. I am interested to see what specific fundamental change or changes constitute your exit strategy. Without necessarily revealing the exact parameters, do you have specific indicia that precisely define for you what you mean by "a *negative change* in fundamentals?" While I like and appreciate your concept, the broad term "negative change" is too undefined and open to subjectivity for me, personally. That is not to say that it isn't a good strategy. I suspect it could be depending upon implementation.
Bill Kraft

Patrick said...

Funny you should mention Enron. If you watched their financial statements, you could see that the company was cratering all the way, even as all the analysts continued to issue buy ratings. Like I said, we sell stocks when the assumptions we made about them are no longer true, or when we think they have risen to at least what we thought their actual valuation was. If a company we like, which we think continues to have good management, has a huge pullback in stock price, we will continue to hold -- or perhaps expand the position. I know most people say never to average down, but that is really a trading strategy and not an investing strategy, at least in my book.

Bill Kraft, MarketFN.com said...

Some more great points, Patrick. Thank you.
Bill Kraft

Nadim... from Florida said...

Dear Mr. Kraft,

I very much liked your "Market Cliches" and also thought myself about a few sayings we commonly use in real life, that could as well be applied to the Market. For example, like Woody Allen's old movie "Take the Money and Run". I especially think about this title when I make a fairly sizeable profit in a certain position after a long agony of living in the house of pain (funny I suddenly think about Jim Cramer). Another common saying is "It ain't over until the fat lady sings!". I especially think about this one when the Market or a Stock Sector deteriorates and I find myself waiting for some sort of a sign (I am sure you are familiar with a bunch of these) that indicates that the Bear Market has been finally brought down to its knees and a Rally is well on its way. My late father used to say something like "Hit Hot Iron!", and I believe what he meant by this is that many investors regardless of the type of investment, are usually afraid of taking a big position into what they have been waiting for so long to come down in price to where they really wanted it, and they suddenly chicken away. Well, my dad was usually not a risk taker, but he firmly believed that when the opportunity knocks, hit hard and hit strong, for maximum appreciation of your calculated risk. And, I believe that my late mother, who never really directly invested in the Market other than by marrying my father, used to say something like "My Mother threw me and the Virgin Mary Caught Me!", and I believe she meant by this something of the same nature to what I mentioned about my father, which is "When the opportunity arises, you have to eventually overcome your fears and transmit a message to your brain that, if not taking a position into this stock is finally now, then when?"

Again, reading your columns is very pleasurable, since they always relate to experiences that almost every trader goes through.

Best Regards,
Nadim... from Florida

Bill Kraft, MarketFN.com said...

Thank you, Mr. Kawar. The only additional thing I would note is that contrary to the saying: "it ain't over until the fat lady sings," the truth is the fat lady doesn't sually sing at the end. The fat lady sings at the beginning. Maybe that is a way to emphasize how important I think it is to have an exit strategy in place from the beginning.
Bill Kraft

Anonymous said...

Fifty years ago, The Rule was to buy the laggard---(in a sector). Any thoughts about this investing strategy--A fast money trader believes it is a bad strategy--however, I never lost money on a trade of this nature.
RSC

Bill Kraft, MarketFN.com said...

RSC, I think that buying the laggard can be a very viable strategy as long as the laggard has positive fundamentals and is showing a technical entry. I was recently asked to review an interesting and soon to be released book, "Wall Street's Buried Treasure," by Harvey Houtkin (Wiley 2008) that, in large part, looks at this strategy. You may enjoy reading it when it is released. Like so many of the sayings, "buying the laggard" has a lot of positives going for it, but it doesn't quite tell the complete story.
Bill Kraft

Anonymous said...

October, this is one of the difficult months to trade stocks. The other are July, January, September, April, November, May, March, June, December, August, and February. Mark Twain.

Bill Kraft, MarketFN.com said...

Ain't it the truth, Anon.
Bill Kraft