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.

Good Trading!
Bill Kraft