McCall’s Call: Buy-And-Ignore Is Dead

August 31, 2011

Deciding to lighten or liquidate a position is the toughest decision to make.

When the stock market moves into correction mode, the old investment strategy of “buy and hold” begins to hit the headlines. Advisors and pundits recommend investors stay the course and not sell their positions even if the market is beginning to crumble.

Matthew D. McCallUnfortunately, this strategy isn’t a strategy at all, in my opinion. Instead of buy-and-hold, it should be referred to as buy-and-ignore, and adherents of this school are ignoring the fact that the market or an individual position could be breaking down. It’s no way to make money in the current market.

To highlight how and why buy-and-ignore doesn’t work, let’s look at the young adult demographic. I’m 35 years old and fall into this category. I understand why my peers can’t stand the stock market.

In December 1998, I was an energetic 22 years old and just about ready to begin investing in the stock market. If I had bought into the SPDR S&P 500 Trust ETF (NYSEArca: SPY) at the end of 1998, it would be at the same price today. That’s right: It certainly has gone up and down in the past 13 years, but there’s no avoiding the fact that between then and now, its price is unchanged.

Keep in mind there were dividends paid along the way, so there were minimal gains, but not enough to keep many young adults in the game. Why would they buy and hold and weather the massive rallies and sell-offs to only have a minimal gain that can’t even keep up with inflation?

Determining When to Sell And When To Hold

Hindsight is 20-20 when it comes to investing. How often have you heard from a family member or friend that they were buying at the low in 2009 or during the recent pullback in the market?

Typically you hear this type of nonsense weeks or months after the market has established a new bottom. Where were they when the market was at the bottom? Probably selling like the rest of the sheep.

When looking back at the history of the market and price patterns, investors are using technical analysis.

Major Wall Street firms often shun the study of the charts, even though they all have technical analysis departments. Using technical analysis and studying past movements in the market can help investors both spot bottoms and trigger sell signals before a sell-off turns into bona fide market correction.

One of the simplest rules on when to lighten one’s exposure to equities is when the stock market breaks below its 200-day moving average. As an example, the S&P 500 Index broke through that 200-day moving average in late July for the first time in nearly a year, and within two weeks it had fallen over 10 percent more.

Making use of the 200-day moving average indicator alone could have saved investors a lot of anxiety. The problem is that selling isn’t as easy as it sounds.



Selling Is The Toughest Part

Anytime investors add new positions to their portfolios, they’re typically in a state of euphoria. The stock or ETF has been on their radar for some time and they’ve convinced themselves that now is the time to buy before its price rises. There’s no buyer’s remorse and they can only envision the new position at a higher price in the future.

Unfortunately, not every position works the way the investor had hoped, which forces a selling decision. In other words, investors have to admit they were wrong, which is one of the most difficult things to do. It’s never easy for a human to admit they were wrong in any aspect of life, especially when it comes to money.

Do Not Overreact

If an investor is able to grasp the need to lighten or liquidate a position, the next problem is emotional selling and knee-jerk reactions. The investors who decided they couldn’t take watching the market fall hundreds of points every day finally gave up in mid-August.

Unfortunately for them, that was probably the absolute worst time to sell. When everyone is selling and it feels as if stocks will never rise again has historically been the best time to buy.

Taking the contrarian view to investing has been a simple strategy that has made investors billions. Just ask the most successful hedge fund managers in the world. Or how about Warren Buffett, who was buying beaten-down stocks in early 2009 and put money into Bank of America (NYSE: BAC) last week?

If there’s one strategy I’ve always followed in my life as an investor and financial advisor, it’s that I’ll never be zigging when everyone else is zagging. Simply put, when have the masses been right?

If everyone was making money, it would be too easy and, in such instances, eventually the trend ends in a bad way. If everyone is on one side of the trade, I suggest you make the tough decision and go against the crowd.

You’ll thank me in the end.

Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a New York-based wealth management firm specializing in investment strategies using ETFs.


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