Buy and Hold Non-Strategy vs. Stop Loss Strategy Hypothetical

I thought I might try and see how Buy and Hold Non-Strategy held up against a Stop Loss Strategy from the 2000 stock market crash to now.

I know when I watched the market recover from the March lows I was tempted to put some money in the market. But I use stops and my stops would almost certainly have been hit. So I stayed out and will stay out until I get a clear signal to go back in.

Even then I will trade with my “play money” not my nest egg money. If I start to see my play money is not getting whipped out I may start to put a percentage of my nest egg money in the market.

Since I don’t do much chart analysis these days I went looking for something that fits with my beliefs about market timing and could give me an indicator that a Bull market might be happening. But more importantly that the high volatility has reduced so I don’t get whipped out with my stop losses.

Then I thought what if I could do a hypothetical comparison on Buy and Hold vs. using a Stop Loss Strategy over the period 2000 to now. Recent stock market history has more relevance to us Baby Boomers.

A quick look at the FinTrend chart

I am a fan of Financial Trend Forecaster. (If you click the chart it will take you to the webs site where you can click on the image to enlarge it). I particularly like the NYSE Composite Index Rate of Change Chart. Take a look at the chart and see what happened in 2000. Great Chart showing the Rate fo Return of the NYSE since 1990 But see how the market starts slowing down in 1998. According to this chart you should have been out of the market by mid 1998 and stayed out until March 2003.

You then get into the market in March 2003 when the rate of change is increasing and that gives you a great return in just over a year.

Then you would be out of the market again in May 2004, and be still out of the market now.

If you were a bit slow on the uptake this chart even gave you a second chance to get out in Oct 2007.

A quick look at the NYSE Composite Chart

You can follow a chart of the New York Composite on NYSE Composite Index. I used this chart to calculate the returns for the hypothetical below.New York Composite Chart 1990 to 2008 ( I included dividends and splits on the chart)

Just take a look at the 2000-2003 bear market. It was very severe. Many Baby Boomers who retired then exited the market in late 2002 with 33% of their nest egg gone if they had bought the NYSE Composite Index.

Those that stayed in did not fare much better because they still had paper losses of 33% with the hope they recovered their money over the long term. But this is what the Buy and Hold guys don’t tell you. That loss meant they only had 67% of their money left to invested in the market when the Bull returned. So it had to work much harder to just recover the losses. This is a point that is not made to Buy and Hold investors. Luckily the market came back even stronger and recovered their money and more besides. But it won’t always be that way.

Let me use an example to compare Buy and Hold vs. Stop Loss Exits. I will use the timing signals on the FinTrend chart above to enter and exit the market and compare the result to Buy and Hold.

First let’s look at Buy and Hold Non-Strategy

If you have $100 in April 1998 and stayed in the market by the end of 2002 it was down to $67. It would have lost 33% of its value approximately.

To get that lost $33 back the remaining $67 would have to earn a 50% return to get back to $100, not accounting for inflation, fees and your pension. So you lost 33% on $100 but need 50% on $67 to get your money back.

Now if you were a Buy and Hold believer you would have $67 on paper in the market when it turned Bullish in February 2003. You would be there right at the start so you would not miss out on anything would you? So then the market rises by 118% to its high in Oct 2007 because you bought the index your $67 giving you $146 on paper, assuming no fees, or pension taken out.

In May 2004 you ignore the exit signal because you are a Buy and Hold kind of guy. Right now the Index is down about 5% from the October 2007 Highs. So your nest egg was worth $139.00 on paper. Right now the market is down a further 8% from the October 2007 high. So your nest egg on paper is worth $128.

Now what if we used a Stop Loss Strategy with the Triggers from FinTrend?

The market peaked on April 1998 you got a signal to exit the market. So you exited the market with no loss because it was the top of the market. You lock in the $100 and put it in safe assets to wait for another entry signal. Let’s assume you entered the market in July 1997 and there are profits to pay taxes on. Between July 1997 and April 1998 you made a profit if 16%. Lets’ assume it was an annual return. Tax at 15% on the profit reduces the amount to $97.60Compound Interest on Money in Safe Accounts

You decide to keep your money in safe investments from April 1998 until March 2003. Using 2.5% interest on deposits and the Compound Interest Calculator from Mortgage Investment’s web site I end up with $108 after 5 years.

It’s now March 2003 and you got the trigger to enter the market. It’s time to get back in the market hurray! You now invest the $108 in the index and ride the bull until you get a signal to exit in May 2004.

The Index rises 42% from March 2003 to May 2004. That gives you a profit on paper of $45. So your nest egg increases from $108 to $153 on paper.

In May 2004 you exit the market because you got a trigger to exit it. It drops about 4% from the February 2004 high. So you lose 4% on exiting the market. Your nest egg is now $147 but you have to pay 15% tax on your profits too. This reduces the amount to approximately $145.

You now have $145 in real money sitting in your bank earning say 2.5% interest.

What just happened here?

You have a real nest egg of $145 sitting in your bank account vs. a paper amount of $128. πŸ˜‰

You were in the markets for only about a year in 1997 to 1998 and kept the 16% profits. πŸ˜‰ But you did have to pay tax πŸ™

You were out of the markets for 5 years from 1998 to 2003 with your money in the safety of a bank or bond and only getting a measly 2.5% interest πŸ™ But you didn’t suffer a 33% loss to your nest egg with the emotion that comes with that too. πŸ˜‰

You went back into the market in 2003 and exited in 2004 after only a year with a profit of 42% on almost the full amount of your original $100 nest egg. It didn’t have to work so hard to give you a good $ return. πŸ˜‰

You avoided large losses (Rule #1) and didn’t suffer the fear and anguish of your nest egg being down 33% with no way to replenish it. Ouch!

In total you made only four investment decisions in 10 years avoided large losses (Rule #1), protected your nest egg and you made 45% return on your money and paid 15% tax on your profits and beat the Buy and Hold returns on paper of only $128. Phew!

Many trading books will tell you the longer you are exposed to the market the more risk you have for a large loss.

It’s not the probability of the loss that gets you, its how much you lose when it happens that can kill your nest egg in retirement. So you have minimized your exposure to the risk of suffering any loss because you have no idea if it will be a large loss.

By reducing your exposure from 10 years Buy and Hold to only 2-3 years using the Stop Loss triggers you reduced your longevity risk by approximately 80%. That is what good risk control is all about.

You now have a nest egg worth $145 in real dollars – money you can touch and feel, vs. a paper nest egg of $128.

Okay so you are timing the market

Okay I know I cannot avoid it. Are you timing the market? You certainly are but it is based on reasonable assumptions and qualitative analysis by market timing specialists who have proven their skill over time. This isn’t guessing or gambling it’s making rational decision based on technical analysis, reason and probability.

It’s not a “non-decision” like Buy and Hold (Hope). FinTrend experts appear to be good at what they do and make decisions on triggers based on sound analytics and judgement. We have a God-given ability to make decisions if we chose to do so.

They tell us to leave our nest egg to the experts in the Mutual Funds. But do they have a monopoly on expertise? Or should I say do they have any expertise? I don’t think so. Why should FinTrend or other market timing firm be any less reputable than Fund Managers who lose Billions and tell you to have faith – the market always comes back? There are many organizations like FinTrend who are expert at timing the market. Like a good financial planner you just have to find them and use their services.

As usual here is my disclaimer. I’m not advocating you use FinTrend or any of the ideas discussed here to manage your nest egg in retirement. If you chose to do so please make sure you talk with your trusted financial adviser first. This was a hypothetical situation only.

I have gone over post this several times hoping to pick up any mistakes. I believe it to be correct now. If anyone finds any errors I am happy to correct them. So please let me know and I will correct it. Let’s get to the truth if we can.

Even if the final nest egg for Buy and Hold ended up being more than using Stop Losses I still believe being in the market only 2 years in 10 and getting a similar return makes good sense when in retirement. .

4 Responses to “Buy and Hold Non-Strategy vs. Stop Loss Strategy Hypothetical”

  1. […] Physics Today wrote an interesting post today onHere’s a quick excerptIt’s not the probability of the loss that gets you, its how much you lose when it happens that can kill your nest egg in retirement. So you have minimized your exposure to the risk of suffering any loss because you have no idea if it … […]

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