Some days ago I wrote about the importance of the Dow Theory for investing and trading.
There is no doubt that technical analysis is one of the most followed approaches to trade the financial markets, whether it is in the medium term or the frenzy and madness of day trading.
However, there is a huge difference between medium term and day trading. Let us say that day trading is based on wrong foundations.
But that is another story.
Buy and Hold approach
Nevertheless, there is another way of investing in the stock markets that offer us some advantages. And from my point of view should be followed for the majority of people who try to invest in the stock market. This way is the so-called buy and hold.
This strategy is intended for the stock market, and not for other markets like commodities or currencies.
There were occasions in the past when I thought that this strategy was for idiots, but I have changed my mind.
It is clear that not everybody may speculate like André Kostolany or Jim Rogers. That is something that just a few people may do. That is why it is not a recommended way of investing for the masses because, without experience, you may get disastrous results.
We should not forget the words of Kostolany, saying that every speculator would go bankrupt a couple of times in their lives. But who can stand it?
Buy and hold failure?
When we “buy and hold”, we should not expect to go bankrupt. Because with this strategy we will hardly get a negative result in the long run, unless our country goes the way of communism. Till that happens, we will always have bull markets followed of bear markets, which will be smaller than the former.
It is true even for countries like Venezuela, where one of the few ways of keeping the purchasing power is through the stock market. Actually, one of the best performance stock markets in the world last year (2013); until we consider the fact that their currency is collapsing and close to hyperinflation.
I remember some years ago when I Venezuelan guy I met, told me that the best way of getting money out of the country was through the stock market. By that time, it was almost impossible to move money out of the country in a normal way (that is what happens in a country that is close to a communist dictatorship). This way the stock market provides us with an example of a black market solution.
Buy and Hold sigle stocks
We should not think that buy and hold strategy is good for single stocks.
The probability of our stock to be the new Apple, Google or Microsoft is very low.
A good time to buy Apple was when it was trading at 1$ many years ago, not now.
But, who knew 30 years ago that Apple was going to be such a huge success?
We might also invest in some “successful” stocks of the time like Kodak or American Airlines and end up going bankrupt. That is why if we try a buy and hold approach it is better if we use a big group of stocks. Or even better, stock indexes like Nasdaq, SP500, Russell, Wilshire and any small and medium cap indexes.
It is something that Malkiel explains very well in his well know book “Random walk down Wall Street”, where small cap indexes outperformed the big ones, by some points; 17% and 15% approximately if I remember correctly.
The small caps would perform worse in the crisis and better in the bull markets.
Advantages and disadvantages of Buy and Hold
There are some problems with the buy and hold approach. One of them is the fact that it is a system for men with nerves of steel. Because it is very funny to see your investments going up when there is a bull market, but it is not funny to see your stocks falling 50 or more percent the bad years.
Some people may get so much anxiety than they will be forced to sell their stocks at the worst moment: that of capitulation.
Therefore, if you are averse to risk you should not try this approach since you need to stand your ground when there is trouble, and trouble there will always be.
If you do keep calm, you will know that someday the market must rebound and go up again.
Buy and Hold international
This strategy may not work well for every market since not all markets are the American markets.
For instance, if we followed this strategy in the Japanese market we would have had very poor results the last 25 years: the time that the “lost decade” has lasted. And still we are far away from the 1989 top of nearly 40.000 points.
It is also true that a similar event occurred during the American Great Depression when the market took 25 years to recover the 1929 highs. But, it is also true that if we invested money throughout the Depression we would have had huge profits from the investments done in the years 1933, 34, 35, 41, 42, 43, etcetera. Which would have gone up 100, 300, 700% the following years. And do not forget the huge dividends of that time. Also, if investors had patience they would have enjoyed a huge bull market in the sixties. So we can say that even the periods of time so bad as the Great Depression are not that bad considering a buy and hold approach.
There is the problem that every time we start a strategy like this, and that is that a big bear market could start anytime.
Imagine you decide to start a buy and hold strategy today and invest your annual savings, let us say, from 1 to 100 thousand $ (depends on your economy) in some index. Then next year there is a huge bear market of 90%. What would you do? Your nerves would be wrecked for sure. But if you kept calm and invest again when the market is 90% down, you may see that in a couple of years there is a big rebound and you are able to recover part of the losses. Let us see a simple example.
Buy and hold investig is possible
Year one: 1000 $ investment. The market falls 90% from 500 to 50.
Second year: 100$ of the previous year and 1000$ invested again when the market is 90% down.
Third year: the market rebounds 100% from 50 to 100. Your investment is 100*2 + 1000*2, which equals 2200, so after three years your first 2000$ invested show a 10% profit even though the market is 80% down from the previous top. And you invest 1000$ of your savings again and carry on.
So we can see that even though the market conditions are awful, the buy and hold strategy is not that bad.
The cases of countries like Spain, France, Italy, Greece; I wonder how long their “lost decades” will last.
You have to be very bold to invest for the long run in countries like Spain nowadays, but everything is possible. Anyhow I would rather use this sort of strategy with more “serious” countries, like United States, Australia, Canada, Singapore, Switzerland – though our favorite should always be the American markets.
The day America falls the rest of the world will follow.
Buy and Hold indicator
The advantage of this sort of strategy is that we will not be thinking every day like crazy about our technical analysis, our stocks, markets, currencies, whatever.
There would be no need of the stress associated with stop losses, limit orders, indicators and buy signals if we have to be long this stock or short that one, etcetera. And all that for profits that in the majority of cases will be lower than those provided by the market in the long run, even though with terrible bear markets in the middle of the process.
Not everybody is Bruce Kovner and have profits of 20% consistently employing technical and macro analysis. Those are just a few guys.
Even though, I still keep the faith that using technical analysis we can beat the market. But I have to admit that I also consider the fact that the buy and hold strategy may be a complement for a good investing strategy for our future.
Of course, this strategy may prove to be wrong in the long run some day (past performance is not guarantee of a future one), who knows?
Maybe tomorrow there is a huge crisis, The Dow Jones crashes 98%, the American Government and the rest of the western ones collapse and a sort of a totalitarian state takes control. In that case “buy and hold” would fail and so technical analysis would.
Though, in a world like that, the stock market would be the last of our concerns.
P.S. This is a personal translation from my spanish blog www.brokerparacompraracciones.com.
Thanks for reading and sharing.