Is Buy and hold most profitable or an opportunity cost?


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I started learning Technicals at the beginning of this year. Even in portfolio management books, it is given that some knowledge of Technicals is a must even for hardcore fundamentalists if they are serious about consistent profits in the market. This is an interesting extract from an article on momentum investing as against fundamental investing:

But is momentum investing the winning strategy for you, the retail investor? What about the buy-and-hold strategy, which long-term investors swear by? One of the basic premise of a buy-and-hold strategy is that you will lose money if you try to time the market (buy low and sell high). So, its better to leave your money in the market. That way, you will never lose out on any of the uptrends.

Passive or active. Lets see how an investor who followed a buy-and-hold strategy over the past five years fared. Say, he bought one unit of the benchmark 30-share BSE (Bombay Stock Exchange) Sensex in July 1995 at 3,332. Today, his investment would be worth 4,857. Thats a gain of 45 per cent in five years, or an average annual return of 9 per centnot what you would expect from your equity portfolio.

But did the Sensex inch up to its current level over this period? Not quite. It fluctuated wildly. It touched a high of 4,131 in June 1996, an appreciation of 24 per cent in one year. From this peak, the Sensex dropped 34 per cent to a low of 2,713 in December 1996. It rebounded again to a new high of 4,605 in August 1997, a gain of 70 per cent in eight months. Only to crash again, this time to 2,741 in October 1998. The next upmove pushed the Sensex to its all-time high of 6,151 by February this year, a return of 124 per cent in 14 months, before it tanked again to its current levels of 4,857.

A buy-and-hold investor recorded paltry single-digit gains because he refused to book profits during any of the uptrends. He would have been better off had he booked profits at any of the peaks, and stayed away from the market after that. In other words, to notch up gains in a volatile market, your stock strategy should allow you to capitalise on uptrends, as well as avoid the downtrends. While a buy-and-hold strategy doesnt allow you to do so, momentum investing does.

But momentum investing is certainly not for the faint-hearted. Momentum investing requires you to be aggressive, keep track of the market and your investments, react to short-term trends, and take on a lot more risk than an investor who follows a buy-and-hold strategy. All in all, you need to have a high level of expertise in stock picking and investment analysis.
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We did a study on this once during my days of working with an asset management company and our finding revealed that if you had made just half the profits generated by each of the bull market moves in the BSE Sensex since 1994 (when NSE opened) one would have made a return in excess of 200%!

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