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When getting started with the stock market, you’ll probably notice most investors fall into one of two camps. One side says you are better off buying stocks and holding them for a very long time without worrying about the short term. But others prefer taking an active approach to their portfolios. Active Trading, t
You’ll probably find some mix of the two works best for your investment goals. But before you click that button to enter an order, you should take the time to learn about both approaches. Once you understand how “buy and hold” and “active trading” work, you can build a strategy that aligns with your risk tolerance and investment objectives.
What Is a Buy and Hold Strategy?
A “buy and hold” approach to your investments works as the name implies. Investors with this preference tend to buy stocks (or other investments) to hold for many years. Sometimes these investors will hold an investment for decades.
Buy and hold strategies are based on the premise that the markets tend to rise in the long term. If you buy a good portfolio of stocks or funds and just leave them alone, the value should steadily increase.
Research shows that timing the markets is very difficult if possible at all. If investors do a good fundamental analysis of each investment and the underlying business continues to perform well, it should be a slow and steady march to capital gains.
But you can’t buy and hold just any stock and expect it to perform well. You should still make a point to do good analysis on each investment and understand why you own it. No matter what strategy you use to invest, never invest in a stock or other investment that you don’t understand.
Over any long period of time, the S&P 500 has offered around 10% annual returns. This is why Warren Buffett is an evangelist of this type of long-term investing. For evidence of how many people believe in this investment style, just look at the swelling values of large, low-fee index funds from providers like Vanguard, E*TRADE, TD Ameritrade, iShares and others.
What Is an Active Trading Strategy?
But some people prefer more excitement in their portfolios. A large number of market participants are interested in capturing value from shorter-term changes in stock prices. These active investors look at company fundamentals but put a big emphasis on technical analysis.
Technical analysis is the use of charts and recent market volatility to find patterns. These patterns can be indications that a stock is about to go up or down. While some people find high levels of success in this area, it is considered quite risky by many investors.
In fact, Benjamin Graham, author of The Intelligent Investor, says that this is not actually investing. He says it’s speculation. And his book is one of the most popular investment books of all time.
It is important to make a distinction between active trading and day trading. Active trading means buying and selling stocks to earn on short-term price changes. Day trading is doing this at a hyper-fast speed, typically buying a stock and selling again within just a few minutes or hours. Day trading is considered incredibly risky, even more so than other forms of active trading.
While active investing has many fans, the numbers say that even most professional active fund managers can’t beat the markets consistently. If someone who gets paid to do it for a living can’t beat the markets, can you?
Weighing the Pros and Cons for Active Trading
The numbers clearly favour a buy and hold approach over an active trading approach. Even if you have a finance education from one of the best universities in the U.S. and spend your entire workday analyzing stocks, you probably won’t beat the market. Most of us don’t have that education or that much time. That’s why buy and hold is most often the best choice.
But in reality, most investors fall somewhere in the middle. I have purchased stocks with plans to keep them for years but based on changes in the markets or the underlying company — or even my own financial plans — have sold earlier. And in other cases, some stocks have been in my account for the better part of a decade, and I don’t have any plans to sell.
But even passive investors need to keep tabs on their portfolio. If you decide to buy and sell individual stocks, take the time to read annual reports, follow quarterly earnings releases and stay in tune with your portfolio.
Deciding on the Best Strategy for You
If you are risk averse and your primary concern is capital preservation and long-term profits, a buy and hold strategy is probably your best choice. If you are okay with more risk and volatility and are willing to put in the time every day to manage your investments, an active trading strategy could work.
Most people are better off avoiding active trading, but it does work for some people. By understanding your goals, risk tolerance, abilities and limitations, you can decide on the right mix for your finances. Are you ready to get into the stock market? read our guide.