Idea: combine "buy and hold" with chatteling [DNO]
 

dno
> Rick,

> I've been doing a little thinking lately
> about how markets operate, and I thought I'd
> share my current opinion. It highlights what
> I consider to be the major difference
> between buy and hold strategies and trading
> strategies.

> Assume for a moment that there is some real
> "fundamental" value for a company.
> This value is the present value of the
> company's cash flows that you would be
> entitled to if you owned the entire company.

> Now what links this theoretical
> "value" to the actual market
> "price" is the possibility that
> somebody *could* buy the company and realise
> those cash flows.. Without that possibility,
> I'm not sure why there'd be such a linkage.

> Having said that, you then need to look at
> how prices work. We all know stock prices
> move around a lot, and some have suggested
> they are just random fluctuations.

> I believe they're the combined result of a
> lot of different market participants with
> different strategies, opinions, and
> outlooks, the day-to-day price is based on
> these.

> Now, unlike fundamentals, which are usually
> reasonably steady, people's opinions about
> the future can change somewhat, causing
> stock prices to move substantially over
> short periods of time.

> The price should still be somewhat *around*
> the fundamental value, however, though
> diversions above this value can happen for
> quite some time (see dot com boom).
> Diversions below the value are less likely,
> for someone with a lot of money (or another
> company) can take it over to align the two
> -- I'm not aware of any equivelant
> possibility for an overvalued company.

> So, now that we have that established...
> Let's look at different time horizons.

> If you have a buy-and-hold strategy of 5 or
> 10 years with a high growth company, you're
> essentially betting the fundamental value of
> the company will increase over that period.
> And the idea is... Over this period, the
> variation due to short-term speculation and
> opinions will be much less than the increase
> due to the increase in fundamental value.

> So for example, let's say a company's VALUE
> is $50 today, but it is PRICED at $60. A buy
> and hold strategy might assume that in 5
> years time, it would be VALUED at $125, even
> though it might be PRICED from $110 - $160.
> The $ difference between value and price is
> smaller compared to the difference between
> the two values over the period.

> Contrast this with a short-term trading
> strategy, which really is looking at changes
> in market expectations.

> If you buy something for a whole 2 weeks,
> for example, the fundamental value of a
> company is likely to remain unchanged, but
> the market outlook for the company can
> change drastically, causing large changes in
> prices.

> Thus most of your return (or loss) comes
> from the market mentality, not the
> fundamentals.

> So what's the difference in risk?

> The difference is... Buy and hold strategies
> are primarily betting on what changes about
> the company's fundamental prospects, and
> trading strategies are bets on market
> opinions.

> What's better? In my opinion, the best
> strategy is one that utilises both methods.

> If you're a long-term investor, probably the
> buy and hold method is more relevant (and
> less risky) for you... But that's just my
> opinion.

> Just don't make the mistake of relying
> solely on buy-and-hold if you're using
> margin loans or short selling. If you use
> your own cash to buy, then what the market
> does short-term is irrelevant... But if you
> use leverage, it can increase your returns,
> but suddenly you need to care about what the
> market does in the short-term, so trading
> considerations come into the picture.

> Best Regards,

> Thomas Rice.