Super Sectors E-Book

John Nyaradi

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Trading Series
• Sprache: Englisch

Seitenzahl: 364

Veröffentlichungsjahr: 2010

Beschreibung

Smart financial strategies that can secure your financial future There are more than 600 exchange traded funds on the market today, and new ones are opening every day. Total worldwide invested assets in ETFs now tops $500 billion. Written in a straightforward and accessible style, Super Sectors outlines a specialized trading system that utilizes standard and leveraged exchange traded funds in an easy-to-follow plan, so that you can identify and invest in the hottest sectors in the world. In this book, author John Nyaradi skillfully shows you how to use ETFs to take advantage of businesses and sectors that are profiting, while also minimizing risk by getting out of the same areas before they start to decline. Along the way, Nyaradi reveals how to best analyze different sectors, such as technology, utilities, industrial, energy, services, and finance, and then discusses which ETFs can help you profit from the opportunities these sectors present. The book: * Outlines an active investment management strategy that will allow you to generate steady success in any market * Details how different types of businesses profit and suffer during different business cycles * Explores how sectors rotation strategies and exchange traded funds can put you in a better position to excel financially * Includes interviews with key experts The "buy-and-hold" strategy of yesterday won't work in today's investment environment. Nyaradi identifies the strongest potential sectors in the future. Find out what will work with Super Sectors as your guide.

Leseprobe

Table of Contents

Praise

Title Page

Copyright Page

Dedication

Preface

Acknowledgments

PART I - Five Wall Street Fairy Tales and Why the Conventional Wisdom is Flawed

CHAPTER 1 - The Bear Facts about Bear Markets

THE BEAR FACTS: ANOTHER BEAR IS OUT THERE WAITING TO MAUL YOUR PORTFOLIO

CONCLUSION

CHAPTER 2 - The Fairy Tale of Buy and Hold

TEN YEARS OF NEGATIVE RETURNS

IMPACT ON RETIREMENT

THE WORLD IS CHANGING

CONCLUSION

CHAPTER 3 - Four More Wall Street Fairy Tales: Conventional Wisdom That Could ...

IS ASSET ALLOCATION THE ANSWER?

THE FAIRY TALES REVEALED

CONCLUSION

PART II - Why Exchange Traded Funds?

CHAPTER 4 - History and Growth of Exchange Traded Funds

FROM ZERO TO 836 IN 19 SHORT YEARS

CONCLUSION

CHAPTER 5 - Types of Exchange Traded Funds

STANDARD EXCHANGE TRADED FUNDS

INDEX FUNDS

MARKET CAP AND STYLE FUNDS

BOND FUNDS

SECTOR EXCHANGE TRADED FUNDS

GLOBAL REGIONS AND COUNTRY SPECIFIC EXCHANGE TRADED FUNDS

INVERSE EXCHANGE TRADED FUNDS

LEVERAGED EXCHANGE TRADED FUNDS

ACTIVELY MANAGED EXCHANGE TRADED FUNDS

CURRENCY EXCHANGE TRADED FUNDS AND EXCHANGE TRADED NOTES

CONCLUSION

PART III - Sector Rotation: What It Is and Why It Works

CHAPTER 6 - Sector Rotation—The Traditional View

THERE’S ALWAYS A BULL MARKET SOMEWHERE

NINE BASIC SECTORS

WILL THIS TIME BE DIFFERENT?

THE BUSINESS CYCLE HAS NOT BEEN REPEALED

WHY USE SECTOR ROTATION?

CONCLUSION

CHAPTER 7 - The New Science of Sector Rotation

IT’S A BRAVE NEW WORLD

ARE THERE ONLY NINE SECTORS?

THE VELOCITY OF MONEY AND THE INCREDIBLE DISAPPEARING INVESTOR

CONCLUSION

PART IV - Trading Systems Designed to Outperform the Indexes

YOUR PERSONALITY

YOUR LIFESTYLE

YOUR GOALS

CHAPTER 8 - Almost Like Buy and Hold

BUT IT’S NOT THAT EASY

CUT YOUR LOSSES AND LET YOUR WINNERS RUN

“ALMOST LIKE BUY AND HOLD” TRADING RULES

CONCLUSION

CHAPTER 9 - The Simple Trading System

CONCLUSION

CHAPTER 10 - The Golden Crossover Trading System

CONCLUSION

PART V - The Sector Scoring System: Trading Concepts, Challenges and Conundrums

CHAPTER 11 - The Five Signals for Entering a Trade

CONCLUSION

CHAPTER 12 - Scoring Your Trades

SELECTING WHAT YOU WANT TO TRADE

SCORING YOUR TRADES: THE HEART OF THE SYSTEM

SCORING THE INDICATORS

CONCLUSION

CHAPTER 13 - Getting Out is Harder Than Getting In

SELECTING WHAT YOU WANT TO TRADE: THE OTHER SIDE OF THE COIN

GETTING OUT OF A TRADE: HOW, WHEN, WHERE

RISK MANAGEMENT AND POSITION SIZE

EXITING A TRADE OR “ WHAT NOW?”

SIGNS OF WEAKNESS

CONCLUSION

CHAPTER 14 - The Psychology of Trading

THE BIGGEST SINGLE RISK TO YOUR TRADING AND INVESTING SUCCESS IS YOU

BEGIN AT THE BEGINNING

GREED, FEAR, AND THE HERD

THREE SECRETS TO TRADING SUCCESS

TRADING AND THE ART OF WAR

THE FIVE ESSENTIALS FOR VICTORY

TRADING WITH THE BUDDHA

WHAT HAPPENS WHEN YOUR SYSTEM STOPS WORKING

HOW TO MANAGE DRAWDOWNS

CONCLUSION

PART VI - Super Sectors: Five “Super Sectors” That Could Change Your Life

CHAPTER 15 - Super Sector No. 1: The Rise of Asia

A CLOSER LOOK AT CHINA

THE STORY DOESN’T END WITH CHINA

HOW CAN YOU PARTICIPATE?

CONCLUSION

CHAPTER 16 - Super Sector No. 2: Energy

THE BAD NEWS ABOUT SUPPLY

THE BAD NEWS ABOUT DEMAND

ECONOMIC, POLITICAL, AND SOCIAL IMPACTS

POSSIBLE SOLUTIONS

POSSIBLE OUTCOMES

HOW CAN YOU PARTICIPATE?

CONCLUSION

CHAPTER 17 - Super Sector No. 3: Health Care

THE AGING BABY BOOMERS

BABY BOOMERS AND THE COST OF HEALTH CARE

GROWTH IN NATIONAL HEALTH CARE EXPENDITURES

POSSIBLE SOLUTIONS AND OUTCOMES

THE EVER-GROWING MEDICAL MONSTER

HOW CAN YOU PARTICIPATE?

CONCLUSION

CHAPTER 18 - Super Sector No. 4: Technology

A CONNECTED WORLD

HIGHWAYS IN THE SKY

EMERGING TECHNOLOGIES

HOW CAN YOU PARTICIPATE?

CONCLUSION

CHAPTER 19 - Super Sector No. 5: Financials

THE FINANCIAL SECTOR

WARREN BUFFETTOLOGY

THE DOLLAR AND GLOBAL CURRENCY MARKETS

INTEREST RATES

PRECIOUS METALS

HOW CAN YOU PARTICIPATE?

CONCLUSION

CHAPTER 20 - Ask the Experts

LARRY CONNORS

DR. MARC FABER

KEITH FITZ-GERALD

TODD HARRISON

GENE INGER

CARL LARRY

TIMOTHY LUTTS

TOM LYDON

JOHN MAULDIN

LAWRENCE G. MCMILLAN

PAUL MERRIMAN

ROBERT PRECHTER

JIM ROGERS

MATTHEW SIMMONS

SAM STOVALL

CLIFF WACHTEL

GABRIEL WISDOM AND MICHAEL MOORE

CONCLUSION

APPENDIX - ETF Resources

Notes

About the Author

Index

Additional Praise forSuper Sectors

“John Nyaradi’s Super Sectors is that rare book that can give anyone—from a relative newcomer right up to the most expert reader—insights into actionable ways to profit from the information presented. From the psychology of investing, to ‘point and figure charting’ and ‘moving average crossovers,’ John shows how trading ETFs with sector rotation can beat the pants off ‘buy and hold’. He clearly illustrates why his theories have worked in the past and makes a good case for why they’ll continue to work in the ‘new normal’ environment since the 2008 market melt-down. His concluding segment on the Super Sectors he sees dominating future returns should contribute mightily to your future financial well being while letting you feel confident that you’re well positioned for what’s over today’s investment horizon.”

—Dr. Paul Price, Founder/Editor, www.BeatingBuffett.com

“If the first decade of the twenty-first century has proved anything, it is that investors cannot afford to let precious time slip through their investment fingers with a buy and hold strategy. Change is occurring too rapidly and trends shift with ever-greater frequency, rendering buy and hold as a high risk strategy unfit for the times. Super Sectors goes right to the heart of this issue and provides investors with the vital tools (and reasoning) that will enable them to take advantage of the opportunities such change presents and to help avoid its pitfalls. Investors who read this book will not let that most precious of resources—time—slip by.”

—Vinny Catalano, CFA, President and Global Investment Strategist, Blue Marble Research; Nonresident Senior Fellow, Information Technology and Innovation Foundation; Former President, New York Society of Security Analysts; Author, Sectors and Styles

“For investors concerned about market volatility and global trends, SuperSectors demystifies the technical approaches used by professional traders and offers simple techniques to reduce risk, manage a collection of sector ETFs, and keep a portfolio tuned into the strongest trends. John Nyaradi’s bonus interviews on the subject of Super Sectors, with more than fifteen investment experts, are also more than worth the price of the book.”

—Mark Kramer, Editor, Confident Investment Strategies

“This book clearly answered why buy and hold is the most dangerous and damaging piece of advice in Wall Street. It reviews what ETFs are and how they work. If you want to manage your own retirement or trading accounts through ETFs, this book is a must for you. It summarized major and basic sectors, and how to rotate with scientific methods and trading systems. With more and more people involved in their own financial management, I highly recommend the book to all investors.”

—John Wang, CEO, AbleSys; Author, AbleTrend

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Copyright © 2010 by John Nyaradi. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Nyaradi, John.

Super sectors : how to outsmart the market using sector rotation and ETFs / John Nyaradi. p. cm. - (Wiley trading ; 468)

Includes index.

ISBN 978-0-470-59250-2 (cloth); ISBN 978-0-470-88030-2 (ebk); ISBN 978-0-470-88031-9 (ebk); ISBN 978-0-470-88032-6 (ebk)

1. Exchange traded funds. 2. Stock funds. 3. Portfolio management. I. Title.

HG6043.N93 2010

332.63′ 27-dc22

2010030440

For Ann, Chris and Dan, with love

Preface

Thanks so much for sharing your valuable time with me and my book, Super Sectors: How to Outsmart the Market Using Sector Rotation and ETFs.

This book has been designed to help you avoid bear markets and prosper during bull markets by deploying sector rotation techniques using Exchange Traded Funds.

Some of the techniques outlined in this book are so simple that a sixth grader could do them while others are geared towards the professional trader.

Whether you’re a novice trader just looking for ways to get started or a seasoned pro, in these pages you’re going to be introduced to valuable trading concepts and get detailed insight into trading systems, opportunities and obstacles so that by the time you reach the end, you will be armed with a powerful arsenal to help you successfully trade Exchange Traded Funds using sector rotation techniques.

If you’ve suffered through the Bear Market of 2008 and feel less financially secure than you did on October 9th, 2007, when the S&P 500 reached its record closing peak of 1565, you’re not alone. Since that fateful autumn Tuesday afternoon, trillions of dollars of assets have been lost in global stock markets and much of that money will likely never be recouped by individual investors. If you lost money over the course of the Bear Market of 2008, I’m looking forward to discussing ways that you can potentially avoid losing money during future bear markets.

However, bear markets aren’t the only reason, in my opinion, to actively trade your assets and I say this because as bad as this bear market has been, the losses suffered since late 2007 are not the worst part of the news.

Stock market activity over the last ten years has proven that “buy and hold” is a dead concept and it’s very likely that going forward over the next ten years, “buy and hold” will continue to be an invalid and ineffective concept. Because over the last ten years, the S&P 500 has generated a negative rate of return and that doesn’t even factor in the ravaging effects that inflation has on your portfolio.

So, in this book we’ll discuss why Wall Street’s “conventional wisdom” may not be effective going forward and we’ll take a close look at the tactical portfolio management alternatives that are available to average retail investors and professionals alike.

Through the pages of this book, you’ll learn how you can take control of your destiny and your financial future and not rely on market forces to determine the outcome of your investing activity.

You’ll get valuable insights into the features and benefits of Exchange Traded Funds and why they’re a great choice for today’s active markets.

You’ll learn about sector trading and how this style of portfolio management can be one of the most successful you can find and we’ll discuss various methods of identifying potential “super sectors,” the sectors of the market that are outperforming the general indexes.

As the old saying goes, “there’s always a bull market somewhere” and through these pages you’ll learn techniques for identifying and profiting from these “super sectors.”

Trading systems will be discussed in detail, ranging from the most simple for people who don’t want to make trading a “job” all the way to the most detailed and complex systems for professionals who monitor the markets on a daily or even minute by minute basis.

Beyond trading systems we’ll look at concepts, challenges and conundrums that all active traders face and how to meet those challenges head on and conquer them.

We’ll identify five “super sectors” that quite likely will advance far faster and far higher than the general indexes due to several economic and social “mega trends” that lie just ahead. We’ll dive into these macro trends and then identify the sectors that will allow you to gain exposure to these “super sectors” over the coming years.

Finally, we’ll have the opportunity to listen to “Interviews with the Experts” in which we’ll hear from well-known experts in the fields of investing, technical trading, economics and various market sectors, and we’ll gain insight into their views about what opportunities and dangers lie ahead for us as investors.

By the time you finish reading this book, you’ll have a wide arsenal of weapons to adapt to your own temperament, trading style and lifestyle so you’ll be able to design a complete trading program uniquely suited to you.

And this is important because the bottom line in today’s post-crash world is that you’re on your own.

You are on your own and you need to arm yourself with the knowledge necessary to survive during what could be very difficult days ahead. No longer can you afford to believe that “the market will come back” or that it will keep going up forever. No longer can you believe that “everything will work out” and no longer can you believe in the “conventional wisdom” spouted by Wall Street and in most of the financial media.

The Great Recession of 2008-2009 has changed everything in the investing landscape, and the “mega trends” I’m going to describe could change it even more drastically. It’s quite likely that Darwinian principles of natural selection will be in play and only those who will be able to adapt to this new world will survive and prosper.

A successfully-managed tactical trading program can be the most difficult job in the world or the easiest. It can be one of the most lucrative things you could ever do or it could lead you to financial ruin. Many, many people have tried and failed at active trading and the goal of this book is to arm you with the tools that you need to be successful.

It’s not an easy path and it’s lined with the school of hard knocks. Along the way you will experience setbacks and failures and feel like giving up, probably more than once. But if you can stick with it, if you can become one of the few who can succeed, you will have the ability to protect and grow your net worth if that’s your goal or you will possess the tools necessary to make trading a full time career or second career to supplement your retirement or regular income.

If you can be one of the few who can succeed, you can literally become like the ancient alchemists, able to create money literally out of thin air. When you sit down at your computer and enter some numbers on an order screen, only two things can happen. The numbers can get bigger and be painted green or they can get smaller and be painted red.

The goal of Super Sectors is to help you find and stay on the difficult and challenging route to green and growing numbers so that you can grow your wealth, achieve your financial goals and meet the challenges of the demanding days ahead.

Finally, I invite you to visit www.SuperSectors.net for more valuable information about sector rotation using Exchange Traded Funds.

There you’ll be able to subscribe to a special membership offer from Wall Street Sector Selector, my online newsletter covering sector rotation and Exchange Traded Funds, as well as get more in depth research, reports and links to other leading financial web sites and portals.

I wish you all the best in your endeavors and look forward to working with you towards your trading success.

JOHN NYARADI Publisher Wall Street Sector SelectorBend, Oregon August 2010

Acknowledgments

Writing a book like this is a mammoth task that couldn’t possibly be accomplished by one person alone, no matter how talented or energetic the author might be.

Many people helped Super Sectors come to fruition and I would particularly like to thank the following individuals for their help, support and invaluable assistance:

Gabriel Wisdom, fellow pilot, Managing Director and Founder of American Money Management, LLC., who made this entire endeavor possible.

My editors at John Wiley and Sons, Laura Walsh and Judy Howarth, for their expert guidance, encouragement and insight.

The financial and investment experts who were so kind to offer their expertise, insights and unique knowledge to make “Ask the Experts” such a valuable portion of this work. These contributors include Larry Conners, Dr. Marc Faber, Keith Fitz-Gerald, Todd Harrison, Gene Inger, Carl Larry, Timothy Lutts, Tom Lydon, John Mauldin, Lawrence McMillan, Paul Merriman, Michael Moore, Robert Prechter, Jim Rogers, Matthew Simmons, Sam Stovall, Cliff Wachtel, Gabriel Wisdom.

And finally, a special thanks to my family; my wife, Ann, and sons Dan and Chris for your understanding and encouragement during all of the hours and days that disappeared so that Super Sectors could become a reality.

PART I

Five Wall Street Fairy Tales and Why the Conventional Wisdom is Flawed

There are many good reasons to actively manage your portfolio but one of the most compelling is to try to avoid the devastating consequences of bear markets.

Bear markets happen more frequently than you might imagine and do devastating and long-lasting damage to investors’ portfolios. But it is possible to avoid these downdrafts and later we’ll get into trading systems ranging from simple to complex that are designed to do just that.

For decades, Wall Street and the financial media have fed investors a steady diet of investment advice and concepts that have been proven to be devastatingly flawed during the Tech Wreck of 2000-2002 and again during The Great Recession of 2008.

The financial carnage has been well documented in the press with trillions in assets disappearing, maybe forever, as investors followed advice like “buy and hold,” “invest for the long term,” and “hang on, it will come back.”

And the result was no different during The Great Recession of 2008 than it was during the Tech Wreck or the Bear Market of 1982 or any bear market dating back to the Great Depression.

In every case, the average retail investor typically bought at the top and sold at the bottom and watched the stock market devour his or her hard-earned savings. As the old saying goes, “the stock market will make as big a fool out of as many people as possible,” or put another way, “the market will do everything it can to separate you from your money.”

In this section we’re going to take a look at the 5 Wall Street Fairy Tales that I feel are at the root of these problems and how they’re a real and present danger to your net worth. You’ve heard of all of these before but we’re going to delve into each one and see why it’s a hazard to your net worth.

And the danger isn’t past once The Great Recession ends because there will be other bear markets and other dangers and challenges along our paths.

So let’s start with a look at bear markets and how they’re an ever-present danger to your portfolio and financial future.

CHAPTER 1

The Bear Facts about Bear Markets

Bear markets are a frequent, normal part of the stock market life cycle, just like recessions are a normal part of the economic cycle and both of these facts create a potentially very dangerous environment for investors around the world.

THE BEAR FACTS: ANOTHER BEAR IS OUT THERE WAITING TO MAUL YOUR PORTFOLIO

Bear markets are defined as drops of 20 percent or more in the overall market typically as defined by the S&P 500, the 500 most widely held stocks in the United States.

Bear markets usually precede recessions by nine months.

Bear markets aren’t as rare as you might imagine. There have been 26 bear markets in history and they have occurred on the average of less than one every six years.

The typical decline of the major indexes in a bear market is more than −35 percent.

Put those two facts together and once every five to six years you expose yourself and your nest egg to the chance of losing −35 percent. The arithmetic regarding losses of this magnitude isn’t pretty, as outlined in Table 1.1.

TABLE 1.1 Bear Market Arithmetic

Amount of LossProfit Required to Return to Breakeven20 percent25 percent30 percent43 percent50 percent100 percent

In recent years we have seen “ultra bears”—in 1973-1974 with a decline of −48 percent, 2000-2002 declining −49 percent and 2008 declining −49 percent.

Recovery from these bear markets can be long and hard. On average, since 1929, the time to reach breakeven has been more than five years, however this time can be much, much longer. The 1929 bear market took 25 years to breakeven, the 1973-1974 bear market took more than 8 years to break even.

From 2000 to 2010, the market has still not managed to hold onto its previous highs, and investors have endured a negative rate of return for more than ten years as we went from the Tech Wreck to momentary new highs and then into The Great Recession of 2008.

In 2010, we heard a lot about the “lost decade” since the S&P 500 generated a negative rate of return between 2000 and 2010. However, it wasn’t the first secular bear market nor will it likely be the last. The most famous bear was the 1929 crash that lasted more than 20 years. Less famous is the bear that ran from 1966 to 1982, a period of 17 years, and as I write this in early 2010, we are still not back to break even from the bear that began in 2000.

Over the course of the last 80 years we have had three secular bear markets lasting a total of 48 years. Put another way, someone who began investing in 1929 has spent 60 percent of his investing career in bear markets with negative or only slightly positive returns to show for his or her efforts.

Figure 1.1 shows what a typical bear market looks like.

In the chart in Figure 1.1 it’s easy to see the devastating drop of the S&P 500 between the beginning of 2008 and the March, 2009 lows. And this type of action isn’t so unusual if we look a little farther back at the Tech Wreck of 2000-2002 as shown in Figure 1.2.

Comparing the two charts, a couple of interesting facts immediately stand out. Both bear markets started from approximately 1500 on the S&P, only nearly a decade apart from each other.

FIGURE 1.1 Bear Market of 2008 Chart courtesy of www.StockCharts.com

The 2000 Tech Wreck declined approximately −48 percent over 3.5 months while the Bear Market of 2008 declined a total of approximately −55 percent over five months.

And the subsequent rebounds look very similar when put side by side. Figure 1.3 shows what the last ten years look like altogether:

In Figure 1.3 we can see how in very real terms the stock market, as measured by the S&P 500, has generated a negative rate of return since 2000. And for many investors who tend to buy high and sell low, the returns have been much, much lower.

Of course, the picture becomes even bleaker when you factor inflation into the picture and the lost opportunity costs of nearly a decade of your investing life.

FIGURE 1.2 Tech Wreck Chart courtesy of StockCharts.com

FIGURE 1.3 Ten Year Chart of S&P 500 Chart courtesy of StockCharts.com

CONCLUSION

So after looking at the last ten years, the obvious questions must be, “Isn’t there a better way to invest than what is put forth by ‘conventional wisdom?” ’ And “what would your investment returns look like if you could consistently dodge bear market bites?”

The point here is plain and simple. For investors pursuing a buy and hold strategy, it’s a matter of when, and not if, another bear market comes along and takes a big bite out of their portfolio.

In today’s high-velocity markets, where money travels around the world at literally the speed of light, it becomes vital to have a plan to survive and prosper in a world that has changed and possibly changed forever.

Unless you believe in a stock market that can only go up and so will somehow magically take you to your investing goals, the obvious conclusion is that all in all, it would be a good idea to avoid bear markets and protect your capital so you’ll have more to grow during upswings in the market.

The purpose of this book is to outline practical methods designed to give you a chance to make that seemingly elusive goal a reality.

CHAPTER 2

The Fairy Tale of Buy and Hold

Buy and hold is possibly the most dangerous and damaging piece of advice ever given to investors around the world. How many times have you heard words like this?

“Buy and hold is the best way to go.”

“Hang on, it’ll come back.”

“What would happen if you missed the ten best days in the market?”

In the next few pages we’ll dig into the dangers and pitfalls of “buy and hold.”

TEN YEARS OF NEGATIVE RETURNS

Does ten years of negative returns sound like a really great idea? On October 19, 2009, the Dow Jones Industrial Average crossed 10,000 on its way up from the historic March lows of 6,547, and the 10,000 milestone was met with the predictable gushing and cheerleading in the financial press. But what was less heralded was the fact that the Dow had previously crossed the 10,000 barrier for the first time on March 29, 1999, more than ten years earlier.

So, in essence, buy and hold investors in the major index averages, a view often touted as a low-cost, efficient way to invest in the stock market, had just subjected themselves to ten years of no returns.

So let’s think about this for a moment. If you were a salesperson and didn’t grow your territory for ten years, do you think you’d still have a job? If you went from March 1999 to October 2009 without getting a raise or a promotion, it’s highly likely that you would be less than happy with your employer or well on your way to greener pastures.

And so it remains something of a mystery as to why we continue to hear the familiar bromides of the financial experts touting the benefits of buy and hold.

Why does this continue?

I don’t know, but the fact of the matter is that this one piece of poor advice has cost investors trillions of dollars in profits.

Between 1999 and 2010, buy and hold investors lost money. This sad statistic is further compounded by the fact that study after study show that most retail investors actually underperform even the major indexes because of their propensity to buy high and sell low.

Buyers of individual stocks have fared little better and I’m sure that if you talked to holders of MCI, Enron, U.S. Airways, General Motors, CIT, Bear Stearns, Fannie Mae, Freddie Mac and AIG, among others, they would tell you that buy and hold didn’t work out too well for them, either.

Supply and demand is a basic economic fact and rule that applies to all markets. When supply exceeds demand, prices go down. When demand exceeds supply, prices go up. This works in real estate, employment, or any commodity market. The trick is to know whether supply or demand is the dominant force in the marketplace and then what to do about it.

If there is more supply than demand, prices will go down, and you want to be selling before that happens or at least before too much selling has taken hold and saddled you with a big loss. If there’s more demand than supply, prices will go up, and you want to be in the market soon after they start climbing.

Buying and holding is like wearing your swimsuit year-round and standing by your pool. You’ll be fine in summer, but when winter comes, you’ll get frostbite.

You wouldn’t think of driving a car with no hands or wearing a swimsuit on a ski vacation, so why would you consider one fixed strategy for rapidly changing financial markets and economic conditions?

A buy and hold investor has no regard for fundamental economic rules like supply and demand and so he puts himself at risk before irrevocable forces in the marketplace. If demand is in control of the markets, he’s in good shape because prices will go up, but if supply has the upper hand, he is destined to lose and perhaps lose significantly and for long periods of time.

So in my opinion, buy and hold is a highly risky strategy.

The idea that you can buy a stock or mutual fund and hold it for ten or twenty or thirty years and automatically come out a winner is simple and appealing. Just buy and hold. Nothing to it. Because over time the market always goes up, and so the only possible outcome is a positive return.

Buy and hold could be an acceptable strategy if you have twenty or thirty or more years to wait for the market to “come back” after a decline. But how many people have 30 years? Plus, there’s no guarantee that 30 years is any kind of magic number.

Over shorter periods, bonds have outperformed stocks and the sobering fact that we all face is that most people don’t have thirty years. Even for someone just starting out, it’s highly unlikely that most investors could hang on for thirty years through the ups and downs of volatile markets.

Buy and hold is the lazy man’s way to try to invest in the stock market. The truth is that there is no easy way to make money in the stock market, particularly since the onset of The Great Recession.

Buy and hold is lazy and it is easy. A financial advisor doesn’t have to learn anything about money management or risk management or trading or technical or even fundamental analysis to put you in a buy and hold investment. Just buy a mutual fund or ETF and hang on and the market will save you and everything will be fine and the advisor can earn his fee for doing nothing. A good set-up if there ever was one.

In a long term bull market, this approach works fine. But with two major bear markets in the last ten years, buy and hold is a risky strategy at best and downright dangerous at worst.

As you can see in Figure 2.1, over the past ten years, buy and hold has gone nowhere and very likely has gone backwards for a couple of reasons.

First of all, retail investors tend to get out at market bottoms and then they tend not to come back until far into the rally, if at all, and so actually underperform in buy and hold.

The second reason is inflation because with nominal inflation rates of 2 to 3 percent a year, these indexes have actually generated significant negative rates of return over the past ten years.

In both the Tech Wreck and The Great Recession, people watched helplessly as their nest eggs imploded by huge double-digit percentages.

Finally, if and when the indexes ever get back to their previous nominal highs, many investors will still be 20 percent or more in the hole because of the effects of inflation on their stagnant portfolios over the course of ten or more years.

IMPACT ON RETIREMENT

Retirement plans have been devastated, families have been mauled, college choices limited because of the two vicious bear markets that hit during the decade between 2000 and 2010, and this pain will likely continue for years to come as people struggle to recover from the destruction their net worth encountered during the Bear Market of 2008, the worst bear market since the Great Depression.

FIGURE 2.1 S&P 500 1999-2009

Chart courtesy of StockCharts.com

And just because it looks like the Fed managed to avoid a “depression,” it doesn’t mean that a bear market can’t happen again. Just check out a couple of recent declines and what they have meant for investors. Figure 2.2 graphically depicts the horror of Black Monday, October 19, 1987, when the Dow Jones Industrials suffered its worst percentage drop in history.

In Figure 2.3 (see p. 14) we see the whipsaws that rippled through the Dow Jones Industrials during 2000 at the start of the Tech Wreck. And in Figure 2.4 (see p. 15) we see the Tech Wreck and its devastation.

Of course, stock market crashes and reversals aren’t limited to the United States. Figure 2.5 (see p. 16) clearly depicts what has happened in Japan over twenty-plus years.

FIGURE 2.2 Dow Jones Industrials 1987 Chart courtesy of StockCharts.com

The Nikkei clearly points out a possibility that we are mostly unfamiliar with: Bear markets can last for decades. In 1990, the Nikkei Index was north of 30,000 and in late 2009, it stands below a paltry 10,000, approximately one-third of its former value.

Declines like these are particularly devastating for people in retirement or near retirement and that’s why The Great Recession will have such a long-lasting effect on American society. The Great Recession came along in 2008 at precisely the time when the massive juggernaut of the baby boom generation should have been in their peak earnings and investment years.

But instead of accumulating wealth in their 401ks and home equity, what happened was that their home values were destroyed in the housing crunch, their portfolios were smashed in the bear market, and many people were thrown out of work, downsized, or found themselves working for reduced wages at just the time they should have really been making hay.

FIGURE 2.3 Dow Jones 2000

Chart courtesy of StockCharts.com

The result is predictable: More and more people have had to put off retirement and work longer than they had planned. Many will not have as much money for retirement as they expected, and many will not be able to retire at all.

Overall, baby boomers approaching retirement age have experienced a drastic decline in their standard of living during what should have been their peak earnings years and they can expect to be able to have less money for vacations and dinners out and entertainment when they hit their “golden years.”

The impact of the bear market is real and long lasting, and even more so in today’s world where so many traditional defined benefit plans have been replaced by 401ks.

FIGURE 2.4 Tech Wreck 2000-2003 Chart courtesy of StockCharts.com

More problems related to buy and hold exist in the 401k world. Nearly half of workers over age 55 have less than $50,000 in savings and most eligible workers don’t contribute annually to a 401k because they don’t have enough income to make ends meet and still contribute to their retirement accounts.

So let’s take a hypothetical example of a guy approaching retirement who saw his 401k decline from $800,000 to $500,000 during The Great Recession and associated bear market. Using a standard rule of thumb of extracting 5 percent of a retirement account’s value to fund retirement, he would have had $40,000 in annual income before the bear market but now only has $25,000 to withdraw each year from his depleted principal balance. So this leads to a lot of bad choices such as having to work longer, sell one’s house, send the wife back to work, or move in with the kids.

FIGURE 2.5 The Nikkei Index 1988-Present Chart courtesy of StockCharts.com

You can clearly see why buy and hold is a dangerous gambit and why it’s imperative to find a better way.

Popular financial press and theories will tell you that it’s “impossible to beat the market,” but I know for sure that simply isn’t true. I personally know managers who consistently “beat the market” and you’ll meet some of these people later in the book and gain some insights into how they’re able to do what most pundits say is impossible.

I know for sure that they’re not smarter than you or me, but they are more knowledgeable, far more knowledgeable than the average retail investor. They have educated themselves and learned their craft. They have a trading plan. They run their trading like a business and they have the discipline to stick with their plan through thick and thin.

There’s no reason in the world that you can’t do the same thing. And if you do, whether using the techniques outlined in this book or finding other techniques well suited to your personality, you’ll find yourself very likely sleeping better and building your net worth faster and more efficiently than ever before.

You’ll also be able to avoid this long litany of sad facts:

• At of the end of 2009, the major market indexes are still well below their ten-year highs, meaning investors have lost ten years of their investment lives.

• In addition to not realizing any capital gains, investors have lost purchasing power of more than 20 percent due to the constant march of inflation.

• A decline of 50 percent like we experienced in 2009 requires a gain of 100 percent just to break even.

In my view, buy and hold is a lot like driving your car without insurance. You are out on a limb, exposed to unlimited liability, and are very simply an accident waiting to happen over and over again.

As a buy and hold investor, you’re saying that you’re willing to let your future be controlled by market forces rather than taking charge of your own destiny. You’re willing to let the law of averages determine what kind of retirement you’re going to have, and if you’re unlucky enough to match up your best earning and savings years with a bear market decline, the outcome will not be positive.

Worse yet, if you’re already retired, a huge decline could easily result in your running out of money before you die. And that would be the worst of all worlds.

However, there is an alternative, and that of course is active management, whether you call it “market timing” or “trading,” dirty words in Wall Street’s lexicon. I call it active management or tactical management and in my view it’s a terrific way to sidestep bear market declines and so preserve your capital and allow you to outperform the market during good times.

Warren Buffett got it right when he said there are only two rules of investing:

Rule No. 1: Don’t lose money Rule No. 2: Don’t forget rule #1.1

That’s what active portfolio management is all about, because if you don’t lose money during downturns like we saw in 2008, then you can move ahead when the bull market returns, as it inevitably will. Plus, if you don’t lose money during downturns, you only have to capture roughly 30 percent of the upside move of a bull market to beat buy and hold. This fact alone allows you to maximize your gains while minimizing your exposure to market risk and drawdowns.

You can “invest for the long run,” as so many financial pundits would have you do, or you can deploy a tactical trading plan designed to take advantage of rapidly changing financial and market conditions. I prefer the tactical option because “investing for the long run” reminds me of famed economist John Maynard Keynes who said, “In the long run, we’re all dead.”2

THE WORLD IS CHANGING

Most professional money managers and brokers have long been supporters of “buy and hold” because it’s inexpensive and it’s easy. However, after the carnage of the most recent bear market, many advisers are beginning to look for a better way to manage their clients’ assets.

An article from the Wall Street Journal Digital Network reported that “about 15 percent of the 500 advisors polled by consulting firm GDS Research LLC of Sherborn, Massachusetts, and Practical Perspectives LLC of Boxford, Massachusetts, say they’ve made significant changes in the ways they manage money.”3

Will Hepburn, Chairman of the National Association of Active Investment Managers (NAAIM) and President of Hepburn Capital Management told me that “buy and hold is not for everybody because it’s a very high risk strategy. Just look at the drawdowns a buy and hold account experiences.”

I asked Will if he had seen a change in investment advisors’ attitudes towards active trading and tactical management, and he replied, “Since the bear market began, we’ve had a surge in membership and inquiries from advisors. The Great American Investment Creed is to buy low and sell high, but few advisors had any idea about when their clients should sell. Now many of them are looking to the NAAIM Survey of Manager Sentiment for guidance. I call it the ‘NAAIM Number’ and it’s the average exposure to the stock market across our membership that’s reported in a weekly survey. A growing number of advisors now realize that more bear markets are a real possibility and they need a way to know when it’s time to be in the market and when it’s time to be out.”

CONCLUSION

In summary, the crowd that always preached buying a mix of stocks, bonds, and cash and then holding those investments forever is changing its tune as a result of the Great Recession. The reason for this evolving attitude is clearly evident if you just take a quick glance at Figure 2.6. Over the last ten years, the major U.S. indexes have experienced a “Lost Decade” of negative returns.

Many would argue that this “Lost Decade” is an ongoing secular bear market that has many years to run, and if that is the case, “buy and hold” very likely won’t get you where you want to go and perhaps active management or tactical management could offer a better alternative.