Buy and Hold Strategy - Pros and Cons

The so called buy and hold strategy has been popular for amatuer investors or those looking to park some money into the stock market believing that in the long run, they will have greater return on their investments than other asset classes such as property, government bonds or term deposits. There are various indications that show that this is in fact a failed strategy as investors who adopt this will be worse off.

Here is a list of arguments both for and against the Buy and Hold Strategy summarized from the book by Leslie N. Masonson

Buy--DON'T Hold: Investing with ETFs Using Relative Strength to Increase Returns with Less Risk

For:
1. Stocks perform better over the long run compared to bonds, treasury bills, cash and is the only way to beat inflation.
2. A diversified portfolio of stock, bonds, mutual funds will provide positive return over the long term.
3. It is better to stay in the market all the time since no one can predict up or down.
4.Stock market always recover and go to new highs, so it is better to be patient and stay with it.
5. If investors miss the best rallies, they will miss out on the best returns so it is better to stay invested in the market.
6.Picking high and low points to sell and buy does not work, so might as well stay invested and also to avoid frequent buy or sell commissions.
7.Only commission is the initial purchase so better to be invested for the long term.
8.Buying no load active and / or passive funds does not incur commission.
9. Rebalancing a portfolio annually to achieve a certain stocks to bonds ratio yearly is good. There are no tax consequences if this is for retirement account (for US holders?).
10. Tax only need to be paid when stocks are sold. For the case of mutual funds, they do pass on capital gains yearly and investors need to pay some tax on this. This is more relaxed for retirement accounts. (for US holders?).


Against:
1. Sometimes may take up to 20 years to break even since there is usually bear market in this time frame. Historically some 20 year period may return negative after inflation is accounted for.
2. Exposed to bear markets and crashes. If you just buy and hold, you will lose what you have gained and need to wait for the recovery.
3. From 1998 to 2009, buy and hold strategy did not return positive return after inflation is accounted for.
4. Diversification may not help as some bear market or crashes affect all industries.
5. There is no defense in a bear market. Buy and hold is only effective during a bull market.
6. Missing out on strong market rallies is not as bad as avoiding the worst daily, weekly drops in the market. Movement of prices in a crash is much more severe than in a charging bull market.
7. Commissions on buying and selling stocks have dropped. ETFs in particular allow exposure to diversified set of stocks.

Technical Analysis (Gann Charts) - Dow and All Ords Nervous

It's been some time since I last put up the monthly graphs and I just thought it was time to revisit both monthly and weekly graphs.




Things to note from the All Ords monthly graph:
i) x=80 is March 1991 and x=280 is Nov 2007
ii) The two gradients Gann +7.5 and Gann+10 has acted as an envelope for most of the 1990s decade.
iii) The period of early 2000s saw the irrational exuberance indicated by the large peak breakout of the envelope.
iv) The GFC made a low but supported by the Gann+7.5 line. The bull run from March 2009 until now saw it rising steeply from the Gann+7.5 and is now just over the Gann+10.
v) Big question is will the Gann+10 act as a resistance or will it break through? The key is to wait for a definite signal.

It is interesting to note that the Gann angles not only act as "Barriers" (ie resistance or support lines) but also as a "Tracker" where the graph actually fluctuates along it.



On the Weekly All Ords graph - If you have been following my blog, about two article ago, I wrote on the "Squaring of Time and Price of the Global Financial Crisis GFC" (Sep 2009). In that article I found that a factor of 52 was key to revealing the square relationship between time and price. So for this Weekly graph, you will notice that I changed the Gann-32 line into a Gann-50 line (tracking the GFC down) and added a Gann+50 line (tracking the post March 2009 recovery). I used 50 because I did some recalculation and the results were better than 52, not to mention 50 is a nice round number.

The result of these changes (compare with previous blogs) is that the new Gann+/-50 track the graph even better. We can use this graph to confirm a change in trend if the current bull run is to end.



On the weekly Dow Jones, we see the graph approaching the Gann-5 and there's no reason why it should not at least touch that line before any pullback. The intersection between Gann-5 and Gann+10 would be interesting to watch.

The recent bull run has gone on for almost 8 months. The bears have become bulls while the bulls have become a little nervous. Many are expecting a pullback of some degree. However, the weekly graphs based on the Gann angles shown here do not indicate any strong resistance soon, with the exception that the monthly All Ords just broke through and important resistance. The market has dropped in the last few days but the key is to wait for confirmation of trend if we are to jump in the opposite direction.

Technical Analysis - Gann weekly 12Jan09 on Dow Jones and All Ords

Following from my post in early January in which both the Dow Jones (DJIA) and Australian All Ordinaries (XAO) were sitting on turning points, recent movement may confirm a break in the trend.

The Dow seemed to have broken the support angle Gann20 coming from the bottom. If so it may be heading down to another support line, perhaps Gann10 from the bottom (which is not plotted yet). It may also find support at the downward angle Gann10 (yellow line). Both of these support are a long way off, suggesting we may have a large drop to go.



The All Ords, since late November, has actually went down, touched the Gann2.3 (pink) support but has bounced up since Christmas. Although it does not seem to have broken the support at this point, rather it is still close to the support angle and thus waiting for the next break-out, we should consider what's happening in the US. If so, the recent break downwards in the Dow, would suggest the All Ords is most likely to break the Gann support and head further downwards.

Technical Analysis - Gann Angles on the current Dow Jones Industrial Index DJI

This is an interesting week. Not only is the American market set to respond to a major stimulus package, but the Gann angles show that we may be at the cross roads. Before analysing the current DJI graph, please note the following technical details:

- The chart below is a weekly chart. Daily chart are too volatile, monthly is good for a longer term view.
- Gann love the 45 degree angle. But that was possible only because the weekly time scale is comparable to the price time scale of certain stocks in Gann's time. Eg. it is reasonable for a stock to move one unit over one week.
- My adopted Gann angle will be a gradient of 10 for the DJI. i.e. 10x1 gradient correspond to Gann's 45 degree. In fact, I will be using gradient terminology rather than degrees.
- The purple line starts from the Origin or Zero, at a particular significant time, eg on the date of the highest point.
- Unlike other charting techniques which simply "connect the dot" from peak to peak or trough to trough, Gann's methods are based on fixed angles or gradients. Gann's lines DO NOT aim to the fit graph, rather the graphs can be predicted by Gann's lines.

(The technical notes above should also be applied to my previous article on Gann)





So the BIG question, "ARE WE THERE YET"? Have we reached the bottom?

1. Usually a bear market has about 3 or 4 drops. But note the 1929-32 had a first big drop followed by 6 other drops for over 2.5 years. In the Credit Crunch of 2007-08 (hopefully not -09 as well) there have been 3 significant drop followed by a huge drop in late September 2008 (the fourth one). The bear may be over ???

2. It certainly crossed the major -10x1 gradient but not really near the -20x1 gradient to find support. So it can drop to that level next.

3. The 20x1 gradient starting from a value of 0 at the date when DJI was highest ever, is acting as a support from the bottom. More interestingly, it looks like it is squeezed upwards by the -10x1 line. It may bull towards 9500 on 27 Jan 2009. Or if it breaks below 8500 this week, it may crash further.

4. Looking purely with time, it is 60 weeks since the major high. To square the time and price, anticipate the DJI to move down 6000 points from 14200, which is about 8200 within this week.


So the final answer is All of the Above; ie. monitor the signals mentioned above. To put it simply, if it does not follow the purple line up, then it will drop further.
It is very interesting that it rests so nicely on the 20x1 line from "O".

Ten simple rules to avoid large trading losses (with CDFs)

This article is published by CommSec and is intended for CFDs. However the techniques seem to be quite useful for other derivatives and even trading stocks directly.

"Avoiding the commitment to failure

In theory, when a trader experiences a decline in the value of an investment the desire should be to exit the position. But often the opposite occurs. A behavioural concept known as ‘escalating commitment to a chosen course of action’ can be the downfall of a trader, especially when using a leveraged product such as contracts for difference.

Forced compliance studies induced individuals to perform unpleasant or dissatisfying acts in the 2003 text The Social Psychology of Organizational Behaviour, edited by Leigh Thompson. Because the individual could not undo the consequences of the act, it was found that the individual biased his attitude towards
the experimental task so as to reduce any negative outcomes resulting from the behaviour. By justifying prior behaviour the decision maker increased his commitment in the face of negative consequences and the higher level of commitment in turn led to further negative consequences.

Probably the most famous example of escalating commitment to a chosen course of action was the Vietnam War. In a 1965 memo from former Under Secretary of State George Ball to US President Lyndon Johnson, Ball wrote “Once we suffer large casualties we will have started a well-nigh irreversible process.
Our involvement will be so great that we cannot - without national humiliation – stop short of achieving our complete objectives.”

In the trading world, once a trade turns bad a trader can rationalise his bad decision and increase his commitment by either staying in the position as losses grow or by adding to the position in what is commonly known (with long positions) as averaging down.

When a losing trade is not exited quickly, because of the leverage factor, losses can mount exponentially. Nick Leeson’s futures trading in Singapore in the 1990s was an example of an escalating commitment to a chosen course of action in a leveraged product. But small private traders managing less spectacular
amounts of capital should also be aware of the phenomenon because it is not uncommon for small traders to end their trading career with a single catastrophic trading loss.

Some simple rules can help you to avoid the big loss and stay disciplined:

1. Trading is a 50-50 prospect. A trader can win less than 50% of the time and still be profitable. Success or failure is not due to the amount of winners you pick but rather the dollar return on winning trades versus losing trades. In other words, be consistent with your risk amount and stop losses and aim to make your wining trades larger than your average losing trade.

2. Markets don’t behave rationally therefore sticking to a losing trade can never be rationalised. Prepare mentally and financially for both scenarios before you enter the trade - winning and losing - by placing stop loss orders and identifying possible price points where the trend may become exhausted.

3. A study of multiple choice examination habits has shown that going back and changing answers increases the chance of being wrong. Never move a stop loss level once it is set, unless it is in the direction of the trend you are trading.

4. Moving a stop loss order with the trend will help you maximise profits because you are changing your exit level in accordance with the market direction. Some experts advocate never exiting a trade unless it’s on a stop loss order – any other approach is effectively picking a top (or bottom).

5. Always aim to place a break-even stop-loss order after your initial stop loss order. A break-even stop is a free ride. No one ever went broke from not taking losses.

6. Choosing not to trade can be more difficult than taking a trade. When there are no good trading opportunities it’s best to sit on the sidelines.

7. In a bull market your goal is to make money from the upside and in a bear market your goal is to make money from the downside. In other words, it’s smarter to look for short trades in a bear market.

8. The middle of the trend is the “meat in the sandwich”; the beginning and the end of a move are inconsequential. If you want to be profitable only trade the middle of the trend.

9. The bull market for stocks has created a bullish bias. Therefore stocks that are breaking down can do so more quickly than rising stocks as the majority of traders exit long positions. Be prepared to act quickly in a falling market.

10. Information such as technical indicators and economic news can be used to justify a losing position. Price is the ultimate arbiter of value. Follow the price. "

As with all other articles on this blog, this article is not considered financial advise, but merely for thought and discussion.