Buy And Hold: Beware The Devil You Don't Know

I fully intended to write an article bashing the buy and hold strategy, and indeed part of me still wants to write such an article. There is much to bash. I even had a title prepared: Buy and Hold Didn't Die, It Never Really Lived. (Cue the YouTube video of Braveheart)

But alas, it is difficult to confirm the death of buy and hold investing when so few of its defenders actually mean the same thing when they defend it. There are several buy and holds. Here are some samples:

• An article found on InvestorPlace suggests that underweighting certain sectors and changing 25% of the stocks in one's portfolio each year is a version of buy and hold investing. (Is that really holding?)


• An article from Motley Fool says the goal is to find a stock that you "never, ever" need to sell. (How does one make money with that strategy?)


• An article found on Seeking Alpha talks about understanding secular and cyclical bull and bear markets. (Why? To better time the market?)


• Finally, an article from Forbes online drops the names of heavy hitters like Grantham, Siegel, Malkiel, Bogle, and--cue music--Buffett to support sticking with buy and hold. (But don't all those guys have different strategies?)

I'm not sure which buy and hold strategy to bash. But as I was doing some research, I realized it's not so much a specific strategy that bothers me, it's the conventional wisdom that bothers me. Conventional wisdom is dangerous because it is what the masses take for granted, it is the lowest common denominator of understanding. In the form of conventional wisdom, the buy and hold strategy has become a soothing crutch for the average investor, a call to inaction, a warning against straying from the path of pseudo-scientific statistical outcomes.

Don't try to time the market, it can't be done. It's better to do nothing! Just buy and hold. Everything will be fine in the long run. Assume 8% annual returns and plug it into the retirement calculator. Above all, never panic. Do not to interrupt the wealth machine with your simple emotions.

When I think of buy and hold as conventional wisdom, I think of my mother. Like most people, what she knows about investing comes from pamphlets received from kind and well-meaning financial planners. If I were to ask her what buy and hold means, she would probably say that it means you are supposed to keep putting money into stocks (or, more likely, mutual funds) and hold onto them because over the long term, the stock market always goes up...eventually.

You may say this is a caricature of buy and hold, but this is how conventional wisdom works. When the market goes down, casual investors consider it outside the norm and become confused, nervous, or even angry and helpless (What should I do? I can't sell, can I?). A few might become overconfident and throw good money after bad. They trust the strategy and its familiar simplicity, and they are not often presented with alternatives. Worst of all, they are not taught risk management. Why have a stop-loss when the market always comes back?

When buy and holders speak of risk, they are usually not referring to risk at all. They speak of missed opportunities. They trot out charts and studies that show (as always, over the long term) the dangers of not being in stocks, with relative performance (how one does compared with the S&P 500) as the measure of success. However, in this day and age when savings and retirement funds are invested in the markets, when the lines between saving and investing have been blurred, shouldn't people be aware that there have been long periods of time where markets go down or sideways? Shouldn't people be shown a chart of Japan's Nikkei 225 from November 1989 to today?

That should make you think. It's Japan, not Zimbabwe. Now of course it is absurd to say that the past returns of the Nikkei over a certain period of time are indicative of future results (disregarding the similar storyline of a real estate bubble, extremely low interest rates, and a deflationary environment). But it is just as absurd to use buying Microsoft in the 80s as an example of a buy and hold strategy. The truth is that past returns are not indicative of future results, it's more than a disclaimer, and no amount of academic studies referencing the market's history can change that. We can use history as a guide, but that's not risk management. Risk management isn't planning for the norm, it's protecting yourself against the extreme or unusual (read some Nassim Taleb, please).

You may now be thinking that I've decided to just bash buy and hold after all. Not so. (Okay, I did get some shots in.) I respect that some investors, using their own version of a buy and hold strategy, have been quite successful. But some have been unsuccessful, perhaps by picking the wrong stocks and holding them to near zero (yes, smart people have done this). In the same way, there are successful and unsuccessful short term traders who attempt to time the market and use a variety of methods.

My point is not that one method of investing is better than any other. I have my preference, which fits my personality, risk tolerance, time horizon, and skill set. My point is that buy and hold has become conventional wisdom as the "right" approach for the casual investor, whereas day trading has become synonymous with risky behavior. The truth is that while both approaches have risks, only one of the approaches readily acknowledges that risk. So which is more dangerous--the devil you know, or the devil you are led to believe does not exist?

Friday Video Game Update: Will THQ Survive?

Sales of video game software in October were strong, rising 35% year over year compared to expectations of 20-25%. But hold on before you run out and buy a basket of video game stocks, because there are definite winners and losers.

I won't recap the October number, you can read about it here. Instead, I'd like to focus on THQ (THQI) as a cautionary tale. THQ came into the current console cycle (meaning: the release of the Xbox 360, Playstation 3, and Nintendo Wii) in a strong position. The company was growing, and management had a plan to increase their intellectual property. As opposed to licensed games where THQ pays a fee for using certain characters or stories (i.e. to Disney/Pixar, for making a game based on the movie Cars), intellectual property would be fully owned by the company, resulting in higher profit margins. Think Take-Two (TTWO) and Grand Theft Auto.

Additionally, as it became clear the Wii was going to be the big console winner, some speculated that THQ would benefit due to its past success on Nintendo (NTDOY) platforms and a history of family-friendly games. THQ management believed this themselves. Everything was lining up well for THQ. You can read about their plans and their optimism in old conference call transcrips on Seeking Alpha. Here are some highlights from CEO Brian Ferrill on the August 2007 call:

On today's call, I would like to share with you our THQ is continuing to execute on our strategies to drive revenue and margin growth. Specifically, we plan to, one, grow annual revenues from our big family and casual franchises. Two, sequel and extend our growing portfolio of owned intellectual properties. Three, introduce one to three new intellectual properties each year that have long-term franchise potential....

At these years E3, it was clear that Nintendo’s new platforms are truly expanding the markets for video games and we are excited to build upon our heritage as the leading independent publisher on Nintendo’s hardware....

We plan to ship more than 1 million units each of five owned properties, Stuntman, Juiced, Frontlines, MX vs. ATV and Destroy All Humans!

But, in the end, it all comes down to executing on good, popular games. By THQ's own admission, titles like Stuntman and Juiced were simply not competitive. Now I wonder if THQ can survive to see the next cycle. Activision (ATVI) has solidified its position by combining with Blizzard and a gazillion World of Warcraft addicts. Electronic Arts (ERTS) has been struggling, but the sports games keep the cash flowing. Some say Take-Two is a one-hit wonder, but it's a heckuva hit (Grand Theft Auto) and they have arguably some of the best creative talent in the business (Bioshock was very impressive). THQ, in my opinion, doesn't come close with its slate of games.

My friend The Long/Short Trader is more optimistic on THQ (after being pessimistic in 2007), based on the Ultimate Fighting Championship license and a possible takeover bid. While it wouldn't surprise me if THQ got snapped up by Disney or Electronic Arts, I'm beginning to wonder if that isn't the only way THQ can make it. When the next console cycle begins, video game publishers will need to ramp up spending to develop the next generation of games. Even though THQ currently has no debt, they are not expected to make a profit in FY09. They are struggling just when the industry should be near peak profitability for the cycle.

So, the best option for THQ, in my opinion, is to shop themselves to a bigger player. They may survive as an independent company, but they are on the road to being a second-rate publisher. Indeed, the stock shows that they look less like strong and healthy Activision and more like totally dysfunctional Midway (MWY). Ouch. (Click on the chart to enlarge, but beware--it's ugly.)

Low And (Be)Hold, It's A Bear Market Rally

Traders were wondering if the October 10th low would hold in the S&P 500, and today they got their answer, at least for the short term. The result was a huge rally today and an opportunity to go long with a clear risk / reward setup. Please see my previous post for a Context Check, where I mused over whether or not the lows would hold and explained why I carried a bearish bent. The context chart:


The 900 level did not hold, and as expected we quickly fell to 839, which was the intraday low from October 10th. You can see from today's daily chart how the decline sped up when the lows were temporarily broken. Even if you don't "believe in" technical analysis, this is how support levels work. They act as decision points for the market. Once broken, stops are triggered and many traders sell to fight another day. The daily chart today shows the break of 839, and you can see the immediate and dramatic slide after support was broken.


However, even if you do "believe in" technical analysis, today showed that it's as much art as science. Yes, the lows were broken, some stops were triggered, and there was a quick drop. However, the bears ran out of steam. The quick move back up above 839 was a very bullish sign.


So how did I trade this? I had some Ultrashort ETFs (SDS, SKF, TWM) that I bought earlier this week in anticipation of a retest of the lows. They worked well, but when we bounced back above 839 today, it was time to take the gains. The bounce also provided a clear risk / reward setup on the long side. I played on the side of traders who saw it as a successful retest, and I went long with a combination of the strongest and weakest sectors (some call this a "barbell" strategy).

One of the strongest sectors, in my view, is biotech. Amgen (AMGN), for example, was up all day and has shown good relative strength over the past couple weeks compared to the overall market. See the strong chart (AMGN in red, S&P 500 in blue):


Just as quality sectors with good relative strength tend to bounce well in a bear market rally (because people want to own them), weak sectors also tend to bounce rather violently (because shorts cover and people want to bottom fish). Two of the weakest sectors are energy and financials, so I bought the Ultralong ETFs (DIG and UYG). I don't plan on holding them long because they really are terrible sectors, but I will play the bounce with trailing stops. Here's the weak and ugly chart (S&P 500 in green, DIG blue and UYG red):
This type of trading is not for everyone. It requires time to watch the ticks and agility to act quickly. But right now, the only way to make sense of these big market moves is by understanding the technical context and using it to your advantage to take calculated risks. Even though I'm playing this rally, make no mistake: this is still a bear market until proven otherwise, and I will not hesitate to go short again when the risk / reward is in my favor.

Two of Dennis Gartman's rules are especially applicable today:

--Trade like a mercenary guerrilla. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.

--To trade successfully, think like a fundamentalist; trade like a technician.

Disclosure: Long DIG, UYG, AMGN.