Saturday, April 19, 2008

Timing the market vs. buy and hold

There are two different types of traders out there. Those that try to time the market, these trades try to find the absolute best points in which to get in and out of a stock. The other type of traders is the ones who buy a stock and hold on for the long term. These traders believe that the markets may go up and down, but in the long term they go up.

So which trading method is better? If we had a contest right now, timing the market vs. buy and hold, which method would be the best way to pull money out? Of course everyone has their own biases on this subject, but let us examine it.

Investors who buy and hold buy long term companies in hopes that they will eventually go up. It helps to avoid all of the market volatility. When stocks go down you don’t really care because you are in the markets for the long term.

The bad part about this is that the markets do go down. In a perfect world where stocks just go up day after day buy and hold would be the undisputed best way to make money in the market. Because they do go down a buy and holder is not only losing money during crashes by keeping their position, but they are also missing opportunity.

If the markets go down 30% in a year is there a way to make money? If the market is moving there is always a way to make money. This is what gives market timers an advantage. Not only can they making money when stocks go up, but they can also making money when the markets fall. A buy and holder on the other hand will only make money when the markets go up.

It is true that a market timer has a much greater profit potential then a buy and holder, but did you know it could also be safer, if you do it right? That is right timing the market in some cases can be safer then buy and hold.

There are 2 major reasons for this. First, one of the biggest misconceptions is that if you buy a stock and hold it you will eventually make money. This is not true. Some stocks just go down, and down, and then bankrupt. You could lose money waiting for these stocks to come back.

Even if you diversify there is no guarantee that you will make money. The SPY is regarded to be a good market average. It is also said to go up 10% every year on average. But this is an average after many years.

If you would have bought the SPY in 2000 you could have paid $139 for it. At the time of this writing in 2008 the SPY is trading at $138.48. You would not have made money by simply holding it. In fact you would have lost $.52 after 8 years of holding. Clearly you would have to hold onto this stock for much longer than 8 years to make an average of 10% a year.

So let us say that you have 50 years to wait. 10% a year is pretty nice so you decide to buy and hold the SPY. The only problem with that is that you do not know that the SPY will go an average up 10% a year.

Could it? Probably it has in the past. Then again there is a famous saying, “past performance does not guarantee future results.” The SPY could go to $200 it could go to $50.

Market timers could make money ether way but buy and holder investors will only make money if their stock goes up. This makes timing the market not only have a higher profit potential but also could be safer if you trade it right, when compared to buy and holding.

For more information on trading in the stock market visit

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