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Be decisive, Be patient, Don’t be greedy, Don't be stubborn

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Thursday 21 August 2014

Buy-cut-buy vs buy-and-hold strategy

by ckchoy

When stock prices are in uptrend, investors can make profit easily. One may set a target price using TA or FA. It is either making more or making less. For example, one might have taken profit at 10% - 20% gain but upon sold, seeing the share price kept rising and hit 100% gain, he may curse himself not able to ride the bigger gain. Whatever, the heart inside still smiling as he is still making profit, he will not have hard feeling on it.  Everyone can handle profit well.

How about losses?  A lot of investors and people cannot handle losses well including me. But small losses vs big losses do make a different. And many of us can have a control of our losses.
Let's look at these strategies
buy-cut-buy vs buy-and-hold

When market started to move weird, example, small drops bit by bit now and then.  These losses started to accumulate, this may give hints that market is in downtrend. And upon market started to have panic selling and in big plunge, then market may have chance to reach bottom.
As market is dynamic, past history only  good enough for reference, hence the so called percentage drop amount analysis and time period analysis to judge a bottom is not always accurate. For example is it a 40%, 50%, or 80% drop mark a bottom? A 10 years, 8 years or a 4 years mark a economy cycle? For the past economy ran itself going thru the peak, recession and recovered on its own. But nowadays there are interventions like fund injections, bailout and many more steps to shorten the recession but this will make the market reaching its peak fast and slump back to down again in shorter period.

Let's say stock abc dropped from 12 to 10 and an investor decided to buy in, but then stock abc continue sliding to 5  before it hit the rock bottom and climb back to 14.
For a buy-and-hold strategy the investors will going thru the cycle seeing his portfolio in 50% loss, (stock abc moved from 10 to 5) and he needs a 100% gain (stock abc to climb from 5 to 10) and then see a 40% gain finally from 10 to 14.
For a buy-cut-buy strategy, one can buy a stock and then set a stop loss let's say 2%, but must remember to buy back after cut. Usually when market started to move down fast substantially, it may take about 1 to 5 times before we catch in the right rock bottom price. And remember market will not move down in straight line to hit it's bottom, there will be rebounds in between, hence we may even make small profit even though we caught a wrong bottom by using buy-cut-buy strategy. So we can estimate we may need to endure only 6 to 8% loss before we catch the rock bottom price, compared to a 50% loss if using buy-and-hold strategy. And then when the stock price move up to 14, The buy-cut-buy strategy will make 180% gain vs 40% gain of buy-and-hold . The 6 to 8% loss incurred compared to 180% gain will be nothing.

What about if stock abc never recovers and trades around 5 for a very long time? Then for the buy-and-hold strategy can almost say the 50% loss is realized, but for the buy-cut-buy strategy, he only will lose about 6% to 8%
We can apply these strategy to blue chip stocks and non-blue chip stocks. Of course blue chip stocks tend to be lower risk and have higher chance to bounce back and hit even higher priceNon-blue chips on one hand can surge few folds but on the other hand it also can be a forgotten stock and still stagnant at a low price for a very long time.
It depends on your risk profile.

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