Learning to Identify Trends
You may have heard or read about moving averages, or it could be a completely foreign concept to you. Either way, after reading this chapter, you’ll be able to explain the 200-day moving average to everyone you know. You’ll be able to make trades that help you profit and
protect your assets. And you’ll be able to impress people at parties. It helps to understand first what the 200-day moving average is all about before you make it the most-used tool in your toolbox. Used by market technicians and analysts throughout the financial industry, this average is based on a mathematical formula that encompasses a 200-day window and determines the mean (the average) price of a security in that period. As the name suggests, the average moves and changes on a daily basis. The end result after 200 days of data is a smooth, sloping line that defines the overall trend.
Moving averages reflect an accurate and precise snapshot of the markets and can trigger buys or sells. The 200-day moving average can slant in one of three directions: up, down, or sideways. But as with everything in life, I must caution that there are no guarantees. How can the moving average help you? It helps to give you a picture of a clear uptrend, thanks to its characteristic smooth line. This can be especially helpful when markets are going herky-jerky.
In those instances, it can be difficult to see the big picture. Instead of giving a snapshot of the sharp day-to-day movements or becoming mired in them, the moving average tells you where things are headed overall. If it’s sloping downward, you know to steer clear. If it’s gradually moving upward, you’re seeing some progress. The moving average allows you to see the forest and the trees.
Buy-and-Hold’s Funeral March
Some of you may be thinking, “What ever happened to the buy-and-hold strategy? It has worked for me for 40 years.” Well, that may be true, but take my word—and the word of many others—for it: It won’t work moving forward. You might want to be sitting down for this: Buy-and-hold is dead. (And there’s no Easter Bunny, either.) Wall Street’s mantra is losing
steam and support fast and furiously. Investment pioneers Benjamin Graham, Warren Buffett, and Burton Malkiel spewed the virtues of buy-and-hold for years, but the ugly truth is if you are among the investors who have followed this strategy so far this century, you have
In fact, Buffett reportedly lost more than $16 billion in 2008, enough to make Graham squirm in his grave. While that figure doesn’t represent the average investor’s losses, it shows just how disastrous buy-and-hold can be.
The bottom line is, buy-and-hold simply hasn’t worked. If you’re already in retirement or are planning retirement, you might be in a terrible situation. The fact that you’ve lost money and that there’s nothing you felt you could have done about it has had a drastically negative effect on your future plans. You might have considered going back to work part-time, or you might have had to call off retirement for now. It’s an ugly scenario for someone to be in, and it’s even uglier when you consider that many people could have avoided it altogether.
The country is in the middle of a major influx of baby boomers who are now moving into retirement, but many of them are finding themselves in the uncomfortable position of having to put off what, just five years ago, was a certainty.
For example, let’s say that you’re a buy-and-hold investor who had planned on retiring in 2009. You’re turning 66, you know that you have the money to do it, and you are ready. But then a crash comes. Now you’ve lost 40% of your portfolio. Suddenly, retirement for you
seems as far away as childhood. And when will you have the time to make up the money lost? The closer you are to retirement, the less you can afford to hang on and ride both the ups and downs.
You can find evidence of this by looking at the wheel-spinning the markets have been doing: Had you invested in the S&P 500 in 1997 and held on to it through all the ups and downs until early 2009 (and maybe even later), you would be below where you started. All told, that’s more than ten years of investing with little to show for it outside of dividends. And what’s more, you’d be 12 years older. Those of you who are planning for retirement or who are in retirement can tell the rest of you about the pain.
“It’s time to unlearn a common myth about investing,” Jim Cramer told viewers on CNBC in late 2008. “The best way to invest is not to buy a bunch of stocks and just sit on them.” This doesn’t happen often, but I agree wholeheartedly with Cramer. Outside of raging bull markets like the one we experienced in the 1990s, the strategy of buying stocks and holding on to them for eternity no longer works. During bear markets, you stand to lose a whole lot of money, and in sideways markets, your assets will flatline.
But here’s the rub: The term sideways market is somewhat misleading. There’s plenty of market activity, but it’s in the form of a sharp downward move, followed by a sharp upward move. Sideways markets can wear on your emotions. They’re extremely frustrating and, most
important, they burn up a lot of time. Have you ever gotten stuck in the snow or mud? The sensation that your wheels are spinning wildly as you dig a deeper and deeper hole is not unlike the feeling some get in markets that are going nowhere fast.
There are a handful of periods in this century where the market has made no money for ten years or more. For example, an investment in stocks that made up the S&P 500 Index during the periods of 1929–1942 (13 years), 1966–1982 (16 years), and 1997–2009 (12 years) would have amounted to no more than a break-even investment.
From 1997 until 2009, the S&P 500 fell in value an average of 0.4% per year. Through the end of 2008, after two devastating market collapses, the S&P 500 returned 7.1% since 1950 and 7.8% since 1980. In 2000–2008, the S&P’s performance was down a dismal 4.7%, including dividends. You don’t have to retrace the past decade or more to see the damage this outdated strategy can cause.
Listen: Life is short. All of us only have so much time to save for our golden years. I don’t know about you, but I certainly don’t have 10 years’ worth of retirement savings to just up and lose—and then slowly but surely make it up until I’m back where I was before, hoping that there’s not another bust before I’m sent back to the starting line again. You and other investors simply cannot afford to suffer the drastic losses we saw in the recent bear markets.
I had never quite heard the strategy of buy-and-hold put this way, but I couldn’t agree more with Mike Macdonald, an investment portfolio consultant with Toronto-based Second Opinion Investor Services:
“Buy-and-hold is a platitude that is outdated. Everything and everybody needs to be monitored regularly because it is often an investor’s life savings and future lifestyle that is at risk. Buy-and-hold is like an airplane’s autopilot. It works great when everything is going smoothly. Then birds fly into an airplane’s engine and the real value of a live pilot is apparent.
Unfortunately for investors, most advisors were on autopilot and there was no heroic landing.”