Short-term trading may not always be a sure bet, but be careful when making any long-term investments too
Philip Loh 21 June 2009
The benchmark Straits Times Index (STI) plunged from a lofty high of 3,900 points to a low of about 1,400 points in March before staging a spectacular rebound of close to 70 per cent.
So, whether you are a new investor trying to work out an investment game plan or a veteran investor reviewing your investment strategy, the markets appear to be giving very conflicting signals indeed.
Recently, I met many bewildered investors who had this burning question: Is the ‘buy and hold’ strategy preached by many investment experts really working?
Or would they be better off just focusing on a short-term trading strategy and taking quick profits whenever possible?
Not all traders can be winners
Before examining anew the validity of the ‘buy and hold’ mantra, let’s take a closer look at its Siamese opposite, the ‘buy and trade’, or simply, the ‘trading’ strategy.
Over the past months, I’ve found a growing number of investors believing that the best way to ‘play’ this volatile market is to use a short-term trading strategy to participate in the potential upside with minimum downside risks.
This strategy usually involves buying into some selected stocks and exiting the positions once they make some profit, say, a 5per cent to 10 per cent return.
It sounds intuitively brilliant.
However, upon closer examination, an immediate concern comes to mind, as most retail investors may not have the same tools at their disposal compared to their stronger institutional counterparts.
The latter are often the very people retail investors are betting against.
The fact is that institutions account for 90per cent of the daily global stock market volume.
And half of these transactions are carried out by the world’s 50 largest investment firms, which have vast resources and deep pockets to achieve the targets they have set for themselves.
These mutual funds, hedge funds and other traders have access to - and do indeed employ - every possible tool available to give themselves an edge in every trade.
Nevertheless, many novices - mostly executives and professionals - are planning to try their hand at trading, encouraged by the strong equity markets of late and the many so-called experts who sell them sophisticated computer programs that can supposedly ‘out-time’ the market.
Unfortunately, novices who excel at trading paper money often fumble when handling real money.
In contrast, the best traders and managers have ‘risk controls and sell’ disciplines, and they stick to them, so they never hang on to a losing stock or commodity position.
So, if you are starting to trade, do make sure that you first convince yourself why you would be the one out of 100 who will eventually make it to the winner’s roll.
‘Buy and hold’ doesn’t always work
Now, does the ‘buy and hold’ strategy really work in the long run? Let’s examine some interesting facts on the United States stock market.
Since 1871, real stock prices there have grown by only about 2.5 per cent a year after taking inflation into account.
But what about those studies that show stocks growing by about 9 per cent a year?
Well, the partial explanation is that these calculations include dividends which have averaged about 4 per cent to 5 per cent.
And, contrary to what many think, indices do not accurately reflect the actual results turned in by their component companies.
For example, if you compare the current Standard & Poor’s (S&P) 500 Index with the 1950 version, or the current STI with the 1980 version, you will find that the component stocks look very different.
This is largely due to survivor bias, a phenomenon in which poor performers are dropped from an index while strong performers are retained or added.
Indices are ‘buy and trade’ instruments
The truth is that indices are actually ‘buy and trade’ instruments, rather than ‘buy and hold’ instruments.
For instance, General Electric was included in the Dow in 1896, dropped in 1898, included again in 1899, dropped in 1901, and then included yet again in 1907.
In fact, investors today will not recognise any of the companies in the 1900 version of the Dow except General Electric. That’s because many of the component stocks that were dropped then have since gone bust.
Some 60 per cent of the S&P 500’s component stocks have changed in the course of the past 30-odd years. What’s more, most of the large cap companies in the current S&P did not even exist 40 years ago.
To further illustrate this point, let us look at the inclusion and omission of IBM and Coke over the years. Both were added to the Dow Jones Industrial Average in 1932.
Coke was substituted by National Steel three years later, while IBM was replaced by United Aircraft in 1939. IBM was back in the Dow again only in 1979, while Coke was reinstated in 1987.
Clearly, buying and holding the component stocks of the Dow and holding them for long periods would not have produced the same returns as doing so for the managed index.
In fact, the returns may have been quite dismal. That is why investing in index funds, which alter their holdings according to the changes in the index, may make more sense for many investors.
However, due to the dearth of index fund options in Singapore, exchange-traded funds (ETFs) have become the popular alternative for investors looking for low-cost managed indices investment vehicles.
Listed on the Singapore Exchange, ETFs allow investors to buy a basket of stocks that mimic the performance of the entire stock market. They are generally safer than investing in a single stock.
The relentless pace over the past few years with which ETFs were launched attests to the strong demand for them.
The writer is a chartered financial consultant with Great Eastern Life. The views expressed are his own. Comments are welcome at www.philiploh.com
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Why the ‘Buy & Hold’ mantra doesn’t always work
Short-term trading may not always be a sure bet, but be careful when making any long-term investments too
Philip Loh
21 June 2009
The benchmark Straits Times Index (STI) plunged from a lofty high of 3,900 points to a low of about 1,400 points in March before staging a spectacular rebound of close to 70 per cent.
So, whether you are a new investor trying to work out an investment game plan or a veteran investor reviewing your investment strategy, the markets appear to be giving very conflicting signals indeed.
Recently, I met many bewildered investors who had this burning question: Is the ‘buy and hold’ strategy preached by many investment experts really working?
Or would they be better off just focusing on a short-term trading strategy and taking quick profits whenever possible?
Not all traders can be winners
Before examining anew the validity of the ‘buy and hold’ mantra, let’s take a closer look at its Siamese opposite, the ‘buy and trade’, or simply, the ‘trading’ strategy.
Over the past months, I’ve found a growing number of investors believing that the best way to ‘play’ this volatile market is to use a short-term trading strategy to participate in the potential upside with minimum downside risks.
This strategy usually involves buying into some selected stocks and exiting the positions once they make some profit, say, a 5per cent to 10 per cent return.
It sounds intuitively brilliant.
However, upon closer examination, an immediate concern comes to mind, as most retail investors may not have the same tools at their disposal compared to their stronger institutional counterparts.
The latter are often the very people retail investors are betting against.
The fact is that institutions account for 90per cent of the daily global stock market volume.
And half of these transactions are carried out by the world’s 50 largest investment firms, which have vast resources and deep pockets to achieve the targets they have set for themselves.
These mutual funds, hedge funds and other traders have access to - and do indeed employ - every possible tool available to give themselves an edge in every trade.
Nevertheless, many novices - mostly executives and professionals - are planning to try their hand at trading, encouraged by the strong equity markets of late and the many so-called experts who sell them sophisticated computer programs that can supposedly ‘out-time’ the market.
Unfortunately, novices who excel at trading paper money often fumble when handling real money.
In contrast, the best traders and managers have ‘risk controls and sell’ disciplines, and they stick to them, so they never hang on to a losing stock or commodity position.
So, if you are starting to trade, do make sure that you first convince yourself why you would be the one out of 100 who will eventually make it to the winner’s roll.
‘Buy and hold’ doesn’t always work
Now, does the ‘buy and hold’ strategy really work in the long run? Let’s examine some interesting facts on the United States stock market.
Since 1871, real stock prices there have grown by only about 2.5 per cent a year after taking inflation into account.
But what about those studies that show stocks growing by about 9 per cent a year?
Well, the partial explanation is that these calculations include dividends which have averaged about 4 per cent to 5 per cent.
And, contrary to what many think, indices do not accurately reflect the actual results turned in by their component companies.
For example, if you compare the current Standard & Poor’s (S&P) 500 Index with the 1950 version, or the current STI with the 1980 version, you will find that the component stocks look very different.
This is largely due to survivor bias, a phenomenon in which poor performers are dropped from an index while strong performers are retained or added.
Indices are ‘buy and trade’ instruments
The truth is that indices are actually ‘buy and trade’ instruments, rather than ‘buy and hold’ instruments.
For instance, General Electric was included in the Dow in 1896, dropped in 1898, included again in 1899, dropped in 1901, and then included yet again in 1907.
In fact, investors today will not recognise any of the companies in the 1900 version of the Dow except General Electric. That’s because many of the component stocks that were dropped then have since gone bust.
And that’s not all.
Some 60 per cent of the S&P 500’s component stocks have changed in the course of the past 30-odd years. What’s more, most of the large cap companies in the current S&P did not even exist 40 years ago.
To further illustrate this point, let us look at the inclusion and omission of IBM and Coke over the years. Both were added to the Dow Jones Industrial Average in 1932.
Coke was substituted by National Steel three years later, while IBM was replaced by United Aircraft in 1939. IBM was back in the Dow again only in 1979, while Coke was reinstated in 1987.
Clearly, buying and holding the component stocks of the Dow and holding them for long periods would not have produced the same returns as doing so for the managed index.
In fact, the returns may have been quite dismal. That is why investing in index funds, which alter their holdings according to the changes in the index, may make more sense for many investors.
However, due to the dearth of index fund options in Singapore, exchange-traded funds (ETFs) have become the popular alternative for investors looking for low-cost managed indices investment vehicles.
Listed on the Singapore Exchange, ETFs allow investors to buy a basket of stocks that mimic the performance of the entire stock market. They are generally safer than investing in a single stock.
The relentless pace over the past few years with which ETFs were launched attests to the strong demand for them.
The writer is a chartered financial consultant with Great Eastern Life. The views expressed are his own. Comments are welcome at www.philiploh.com
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