It is a simple truth that we never know what the markets are going
to do on any given day or for that matter over any given week. About
the time we think we know, some event occurs that results in a change of
direction. We do have quite a lot of historical information, however,
and that can give us some clues to how the markets or individual
equities may behave. I'll discuss some clues in later articles. For
now, though, for example, we know that over extended periods of time
markets have risen. That phenomenon supports the "buy and hold"
strategy of investing. In the long run, the buy and hold investor seems
to have a pretty good chance of success, but of course, as has been
said, in the long run, we're dead.
One problem with buy and hold investing is that there is no defined
end. Hold until when? As I have often said in my seminars and
mentoring: "Hold until death? Great for the heirs, but not necessarily
for the initial investor." The pure "buy and hold" investor does not
define how long he will hold; it is defined for him. Indeed, he may
hold until death and that probably means he had enough money without
ever having to tap his investments. On the other hand, he may encounter
an emergency and have to sell all or part of his position. In that
case, and I suspect that is the more common situation, he is completely
at the mercy of the moment. If the investor bought when the market was
low and was forced to sell when it was higher, all well and good. But
what if he bought at a peak, like QQQQ in early 2000 and had some need
to sell in the latter part of 2002. If he bought shares of the Q's
around the top in 2000 and sold at the bottom in 2002, he would have
lost more than 80% of his investment. Even today, 7 years later, that
year 2000 Q's buyer would not be back to even. How do you suppose he
currently would feel about his buy and hold investment? That is not to
say that over time he may not profit, it is only to say that "buy and
hold" has pitfalls as well as any other strategy.
I would never discourage a person from utilizing the "buy and hold"
strategy so long as they recognize what they are getting into when they
enter the position. They have no exit, period. If they need to exit
for some extraneous reason, they are at the whim of the market. For
that reason, it seems that money invested in "buy and hold" positions
should be money that the investor believes will not be needed for
anything in the future. If there is going to be any anticipated need,
"buy and hold" needs to be modified in my opinion.
Why sit through the two year plummet of QQQQ and wait more than 7
years for a return to your entry price? I suggest that an exit strategy
be set before the position is ever entered. Suppose you decide you want
to buy a stock because it has been in an uptrend. You like it because
it is moving up. Wouldn't it make sense to determine that you will exit
the position when it is no longer in the uptrend. If it breaks the
uptrend, it is no longer performing in the way it was when you decided
to buy so why hang on? In that situation, when you entered the position
you knew you would exit if the stock broke down through the uptrend
line. Now all you have to do is buy and hold UNTIL the trend is
broken. You have set yourself to cut your losses if the price changes
direction and you have kept yourself in gaining more and more profit if
the stock price continues to trend up.
Now, you don't have to stay in a bullish position during the
downdrafts. What if you really like the company, though? Well, suppose
you did get out when it broke down through your uptrend. There is no
rule that says you can't buy the same stock down the road. Do you want
to continue to hold it if it keeps falling? Get out and wait until it
starts back up and repeat the original procedure by buying shares and
setting a new exit based on a new uptrend line.
I don't mean to suggest that trend lines are the only way to set
exits, but they are a way. Some people may use moving averages or
moving average crossovers or crossovers of indicators. Test exit
strategies yourself by paper trading and see what works best for you.
The bottom line, for me, is to adopt a buy and hold strategy, but for
each trade define the "hold 'til when" exit strategy using something
other than undefined time.
Good Trading!
Bill Kraft
Mr. Kraft's past articles are posted on our website for your review.
