Saturday, December 31, 2011

2011 Market Stats & Day/Swing trading Vs "Buy and Hold"

Where does the time feels like the year really flew by...

With Friday's closing market data, the final stats for how the market fared in 2011 are in:

The Dow was the only one of the three popular indexes to finish in the green, and a bit anemic at that. Nasdaq was in the red and the S&P 500 finished the year just as it began - it's like the year never happened.

Short Term Trading Vs Buy and Hold Long Term

I can't tell you how may blogs and articles I've read that "love" to preach that day trading is bad and buy and hope hold investing is soooo much safer and the smarter choice.

All these articles seem to miss one tiny detail:


Far too many people who write about the benefits of long term buy and hold strategy make it sound like the extra time spent in the market somehow makes that decision safer in the long run.

Most make this call as they don't believe anyone can successfully time the market. Of course, if this were truly the case, then none of us should be in the market, period, since be it long or short time frame, that means we don't have the ability to respond intelligently to changing market conditions.

Here is one good example why buy and hold is NOT a substitute for proper risk management of your investment-

Netflix (NFLX)

Netflix started the year at about $175 and was off to the races in no time. It peaked at about $300 in July, then ran into a brick wall of bad business moves and bad press which started a prolonged descent. It ended the year at $69 and change.

An investor who sold at the peak in July would have had 71+% gains for the year, while the person who "dilligently" followed the rules of "buy and hold" ended the year with about a 60% loss.

Okay, so some will argue that there was no way to know $300 was the peak and it was time to get out then. Fair enough, but proper risk management would have alerted all those who were paying attention that the long term up trend was broken through in August and that was a clear EXIT sign if there ever was one. The exit price at that time was about $246, so a person paying heed would have wound up with a 40+% gain for the year, still very impressive and light years better than the 60% loss buy and holders now have. Even if one missed the first big exit signal, there were many opportunities to exit with yearly gains intact before the floor completely collapsed.

The above chart shows you the inherent weakness of buy and hold strategy - it makes the assumption that the stock will eventually recover and make everything good. The unanswered question is what if it doesn't?

The bottom line is there is NO good reason why anyone should let yearly gains of 70+% turn into a 60% loss. Properly managing your investments mean taking profits when they are high as well as cutting losses.

Another argument against short term trading is you will have to pay higher taxes than if you held onto your investments. So who do you think is happier- the person who made big bucks this year selling in the short term, of which a portion they have to pay taxes on, or the "smart" bagholder buy and holder who can now claim a big fat long term capital gains LOSS?

One more argument is folks will say, just invest in index funds as they are safer than separate stocks. That may be true in general, but the returns can be anemic (see above stats for the year) and in a Bear market can be just as dangerous as stocks to own.

To be clear, I'm not advocating that people start "experimenting" with day trading or short term trading - as they both require study and practice to become proficient. What I am saying is EVERYONE who is in the market needs to understand to how employ proper risk management no matter what time frame you're in. If you have a broker investing for you, it still pays to know about risk management in order to tell if your broker is doing a fair job or not. At the end of the day, the person with the most to gain or lose in the market is YOU and no one else, so it can only help you to know these things.