Rick,

> Excellent. And pretty much *anything* is
> safer than the market right now. Dien might
> disagree with me on that but there was an
> article in today's paper about how even the
> buy and hold people are questioning that
> strategy.

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.