Buy and Hold versus Swing Trading

What is a Buy and Hold strategy: Buy and Hold is a passive form of investment strategy wherein one buys stocks and holds them for a long period of time (multiple years), regardless of market price (fluctuations in the market).

An investor who believes and follows this strategy, selects his stocks actively, but once a position has been taken is not concerned with the market gyrations or the technical indicators.

The Buy and Hold was considered one of the best strategies and widely believed to give the best results on the long run. The buy and hold strategy even today might be one of the better strategies but only if the portfolio is substantially big (more than 15 stocks).

Pros of the strategy:
Buy and Hold strategy has broadly the following benefits:
Low on stress: By trading (actively buying and selling) fewer stocks and not looking at the price tickers on an hour-to-hour basis, it is easier on the heart (read less of BP and heart attacks) of an investor.

Taxes: Since Buy and Hold strategies often call for a time horizon greater than 1 year, the rate of tax is much lower.

Brokerage and commissions: Active trading can prove costly. Traders can ultimately pay commissions (brokerages) and government duties in the tens of thousands rupees each year. A Buy and Hold strategy can allow an investor to invest large sums of money with minimal costs (as brokerage and duties are paid only once and over a long period of time).

Cons of the strategy:
The Buy and Hold strategy may give the appearance of a safer investment model, but like any other strategy it is fraught with risks. The buy and hold killer can be bear markets. If a buy and hold investor purchases a stock prior to a market decline similar to the ones in 2002 and 2008, the investor may have to wait 5-10 years to make any returns on their initial investment. The most bitter note for the buy and hold strategy is that you have to buy and hold (for multiple years) and thus no realized profits. Finally, remember Dow Jones has done nothing over the last 10 years (11,722.98 January 14, 2000, to 10,325 on February 26, 2010) meaning over a period of 10 years investors invested on Dow Jones have made a net loss (plus inflation).

Consider these:

COMPANY PRICE ON Feb 26, 2010 PRICE ON February 26, 2009 CHANGE (%)
BSE-SENSEX 16,429.55 8,954.86 83.5%
S&P CNX NIFTY 4,922.30 2,785.65 76.7%
STERLING BIOTECH 8.45 152.95 -35.6%
TATA COMM. 282.55 408.00 -30.7%
SPICE COMMU 57.30 76.05 -24.7%
KOUTONS RETAIL 353.90 448.20 -21%
BHARTI AIRTEL 279.25 325.90 - 14.3%
HIND. UNILEVER 235.75 253.05 - 6.8%
RELIANCE COMM 157.35 158.90 -1.0%

The above stocks shows that blue chip companies like Bharti and Hindustan Unilever can also give negative returns when the overall market has given 83% return for the same period. Worse still would have been the result on a buy and hold strategy investor who had invested his money in 2007 and early 2008 (portfolio likely to be marginally positive or negative).

What is swing trading: This is a style of trading that attempts to capture gains in a stock within a short period of time. Swing traders use technical analysis to look for stocks with short-term price fluctuation. These traders are interested in the price trends and patterns more than fundamental value of the underlying stock.

The nifty has been moving in a range for the last few months (generally between 4700 and 4950). Swing trading involves buying at the lower levels and selling near the higher levels.

Pros of this strategy: Swing trading strategy has broadly the following benefits:
1. Profits: The trader/investor gets quick potential profits without the need to watch the price tickers on a minute-to-minute basis. It is a great strategy for traders who hold a full time job doing something else and can't follow the market on an every second basis. Since swing traders stick with a stock for several days and sometimes a week or more, the transactions are lower and hence less commissions (brokerage) and government duties. Swing trades can be done on the downside also (i.e., selling short) and thus volatility can be used to one’s benefit.

Cons of this strategy:
1. Loss: The swing trades might go wrong, i.e., the previous range can break up or breakdown, so the trader needs to keep stop loss for each of his trades and thus can make limited loss (extent to the stop loss), although the profit can be unlimited.

While both of the above strategies have their advantages, the Buy and Hold strategy will give best results only when one has a bigger corpus and multiple stocks, so that the laggards can be compensated by the leaders and the portfolio give a better result. The swing trading strategy is for more active traders (less active than daily traders) and can give higher percentage yields over the longterm (when the trades are done in conjunction with technical analysis).