Saturday, November 22, 2008

Buy and Hold Revisited

Around this time last year, I wrote an article in which I warned of the dangers of buy and hold investing. One critical response accused me of "shucking and jiving" and asked for academic publications supporting the value of trading options. The critic went on to write: "Our family has owned Citi-Corp [sic], yes that doggie, since $14 a share..." Back then, Citigroup (C) was trading around $33 a share. Today (Thursday, November 20, 2008) as I write, that "doggie" is trading around $5.35. I hope that fellow hasn't continued to hold. At least, I hope he became aware of the value of options in the form of protective puts that may have saved his bacon.

It seems that each time I address the frailties of buy and hold I get several emails telling me that the buy and hold strategy is the only way to success in the markets. It simply isn't. The Dow and S&P500, are back at 2003 levels and the Nasdaq Composite is about 28% of where it was at the high in 2000. Why would anyone want to hold through drops like those we have recently witnessed? The old refrain of "it'll come back" can be a cruel deceit. A year ago, who would have guessed that there would no longer be a Lehman Brothers or a Bear Stearns or a Washington Mutual? When will those once strong companies come back?

For years, I have advocated that traders and investors have an exit strategy in place before they ever enter a position. I earnestly suggest that something as simple as the break down through a moving average can serve as a way to cut losses. Looking at Citigroup, for example, back when the critic wrote last November, the stock was trading around $50 a share. This past June, it broke down through the 50 day MA around $52.50. That was at least one potential signal to exit. By July, the 50 day MA had crossed below the 200 day MA and the price had fallen to around $46.50. Here was another signal. A support formed around the $45 level in August and September and when the price dropped below the support, there was yet another signal to exit. Using any of those exit strategies -- a break below the moving average, a moving average cross down, or a break through support would be acceptable exit strategies. However, the buy and hold afficianado would have watched the stock tumble roughly 90% to its current levels. Why hold through these downdrafts? The pain has to be intense and if the stock has dropped just 50% in price, it has to go up 100% just to get back to even.

For those who just don't want to sell their stock no matter what, we addressed the subject of insuring the position by purchasing puts in last weekend's article and that strategy is another by which investors and traders can limit losses.

I do want to mention that my new book, "Smart Investors Money Machine" will be available soon! I will let you know when and where to order it when it becomes available. "Smart Investors Money Machine" is designed to have broader appeal to a wider range of investors than the first book, "Trade Your Way to Wealth". "Smart Investors..." deals with a wide variety of ways to produce regular income and, in addition to discussing strategies such as writing covered calls and buying Real Estate Investment Trusts (REITS), the new book explores bonds, annuities, Master Limited Partnerships, dividend investing, and even reverse mortgages. I wrote the book to provide guidelines to a wide range of investors from those coming into retirement to growing families and even for new investors. You don't have to be interested in trading options to find value in this book (though it does include information on trading options for income as well). I hope you order the book and find a lot of helpful information that will add streams of income to your lives in these troubled times.

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


P.S. Save $50 PER MONTH on my subscription trading newsletters!
SAVE on my Under $10 Stock Trader Service!
SAVE on my Option Trader Service!
SAVE on my Trend Trader Service!

Technorati tags:

To comment on Bill's article click on the "comments" link below.

17 comments:

Anonymous said...

Buy and hold was the generally accepted and safest way to build weatlth for the last 75 years. Most people who made frequent, in and out, trades, trying to time the market, were losers during this time. However, like most things, times change. I feel we are in a new environment for the stock market and the time of the 401K and pension fund trusts are unfortunately...over

Sue said...

In the past I've used the tried and true buy and keep however I am also open to trying options but I can't make heads or tails of these. Most people say you have to have thousands of dollars to participate and the chance of losing it all is better than 50/50Is it possible to trade options starting with 1 or 2 thousand and is the bid or ask price per contract (which I believe is 100 shares) or per share?

Anonymous said...

Bill suggests 3 exit signs; but everyone except the buy and hold investors are already out. The real question now is when do we get back in? Let us reverse the 3 exit signs: Get in when resitance brakes, get in when the 50 ma crosses above the 200, or get in when price crosses above the 50 ma.

Chris Austin said...

People buy and hold because they are either lazy or they don't know what else to do. It's very sad to see some people hold on to old investment ideas and loose a significant amount of their retirement. These old ideas come from almost every money manager out there. They seem to have 2 plays in their playbook, 1)"just hang in there and the market will come back" and 2)asset Allocation. Asset allocation really doesn't work when most of the sectors are tanking. They could be right about the market bouncing back, but how long will that take (1 yr, 3yrs or 7 yrs). Meanwhile I've lost the opportunity to preserve or grow my capital. They say that the S&P out performs 80% of the mutual funds. This is not true because all fund managers are bad investors. It's because their fees and the cost of living (time value of money) erode at your profits. Each investor needs to hit there own emotional bottom. They need to become so upset that they are willing to take control of there own investments. I'm convinced that most investors can beat the S&P dramatically, but it takes desire and education. As an investor I need to understand, money management, entry/exit signals methods to protect my capital. There is an investment stratagy for every age and risk tolerance (buzz word), just pick one that fits you.

milt said...

totally agree.... in Hedge Fund Trading Secrets Revealed (pristinepublishing.com)..author Robert Dorfmam exposes the lies Wall St. sold everyone about buy and hold.... great book

Anonymous said...

Buy & hold is right for most, since not very many people are good at timing. If someone was good at timing , they could buy & sell & rebuy & resell, but most buy after rally & sell after decline , which is the opposite of buying low & selling high.

Anonymous said...

How about a good long article on the rewards of short selling. All stocks are trending down and they have been over several months.

Thank you.

milalo@telenet.be said...

Bill, I am very pleased with the fact that you call a moving average cross as a signal to take profit or to cut losses. I am watching the charts already for 5 years and I try to take action when the 5 ma crosses the 20 ma.
When you play this strategy on the monthly time frame and you have the guts to trail the cross you can buy and hold for a long period in my opinion. The same strategy is playable on a 60', a 5' or a 1' timeframe.

Bill Kraft, MarketFN.com said...

Interesting comment, Anonymous. We are certainly in a new environment in that the average retail trader has abilities he didn't have 20 years ago such as the ability to trade quickly and on his own, the affordability to trade options, and the ability to acquire information very quickly. However, I'm sure that getting out of long positions was equally desirable in the relatively regular downdrafts the market has experienced including the crashes.
Bill Kraft

Bill Kraft, MarketFN.com said...
This comment has been removed by the author.
Bill Kraft, MarketFN.com said...

Hi Sue. The bid and ask prices on options are per share and a contract usually (though not always) consists of 100 shares. Option trading can be risky, but there are many ways to reduce risk and in certain cases even to eliminate risk using options. May I suggest you get a copy of my book "Trade Your Way to Wealth" (cheapest at TradersLibrary.com) to help understand risk management and money management using options. I include an Appendix that sets out many strategies and their relative risk as well as the relative amount of capital required.
Bill Kraft

Bill Kraft, MarketFN.com said...

Good point about the entry signals, Anonymous. Of course, the strategies also apply to exiting bearish plays so not everyone is out. Many are involved in bearish plays and they, too, need to have an exit strategy. We just need to keep in mind that we are well served by having our exit strategy in place before we ever make the entry.
Bill Kraft

Bill Kraft, MarketFN.com said...

Some important points, Chris. My new book, "Smart Investors Money Machine," speaks to investment strategies for investors with differing risk tolerances and at various ages. There is definitely a way for almost everyone to create streams of income while staying within their own comfort level, but as you say, they must be willing to learn and understand.
Bill Kraft

Bill Kraft, MarketFN.com said...

Good idea on an article about short selling Anonymous. May be pretty late though.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks for writing, Anonymous, but I just can't agree that buy and hold is right for any let alone most. You are definitely right that most buy at the wrong time and sell at the wrong time. Maybe it is an "unfulfillable" wish, but I would sure like to see investors spend a little time learning how to invest their own money rather than take the "it'll come back" route.
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks, Milt. How is Robert?
Bill Kraft

Bill Kraft, MarketFN.com said...

Thanks for writing, milalo. I'm glad to hear you are using a strategy that works for you. A moving average crossover can be a successful method. There is always an issue with moving averages in that they lag somewhat and in general, the longer the MA, the greater the lag. Traders also need to be aware that MA strategies can also be subject to whipsaws when a stock is trading in a relatively tight range. Nevertheless, I have always liked moving averages and crossovers.
Bill Kraft