Buy and Hold vs. Active Trading

Daniel Penzing
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There are pros and cons to each style of investing.

The Buy and Hold investing style is when you pick specific stocks (or investments) and hold them for the long term. This is especially popular with Real Estate investors, who expect to sell the property at a higher price later.

Some investors prefer to do the opposite – instead of investing for the long term, they like to actively trade, and change their investments on a regular basis. This is what is known as the Active Trading investing style.

Which is better? Well, is quite easy to say there is no right or wrong way to do it (Hindsight is 20-20, right?). However, there are some pros and cons of each option.

The main benefit of the Buy and Hold investing style is that you don’t need to do anything. Seriously. It’s one of the easiest investing styles, as you don’t need to follow the market, do any analysis, or do any research on individual stocks or companies.

Andy Sahn, from the Early Retirement Extreme blog, simply follows the “Three-Legged Stool investing style”: Invest in an S&P 500 index fund, a total bond market fund, and an investor-grade bond fund. Then you simply do your research upfront, and buy and hold. You only need to rebalance every once in a while.

What Is a Buy and Hold Strategy?

There are few investment strategies as tried and true as buy and hold. While buy and hold used to be more popular than it is today, many investors still use it as a way to generate sizable gains. The basic idea of buy and hold is that you purchase a number of shares in a stock, mutual fund, or exchange-traded fund (at the same time or over time), and then hold them throughout the term.

The theory behind buy and hold is that you buy the stock when its price is low or at its value. This is low risk because you’re not paying a premium for an asset. The main goal is to obtain enough of an investment in the company to benefit from its long-term operations and growing value. It’s built around the belief that buying stocks, just like stocks, at the right time can generate enormous returns.

What Is an Active Trading Strategy?

While investing in the stock market is generally a long-term endeavor (most people plan to hold their stocks for at least five years), some investors are happy to trade their stocks on a regular basis. This requires a well-developed trading strategy and a willingness to take risks that investors may not be comfortable with.

When you’re developing an active trading strategy, consider your goals. Are you primarily interested in growth? Do you rely on dividends for some, if not most, of your long-term return? Are you attracted to the short-term profits that can be gained from frequent trading?

Each of these goals will result in an active trading approach that’s different from the others. The risk level will change and the basic approach will also be different. The same is true with respect to your investment timeframe. Someone with a longer investment timeframe will be comfortable taking on significant riskier and less frequent trades than someone with a five year investment timeframe.

Arbitrage Trading

Arbitrage trading involves the simultaneous purchase and sale of similar securities on different exchanges. Arbitrage is based on the theory that prices of similar securities on different exchanges should converge over time. These trades are generally high-risk trades that can be profitable but that also carry significant risk.

Weighing the Pros and Cons

Deciding to be an active trader or a buy and hold investor is a big decision that only you can make. Both strategies have their proponents, and there are many elements that you must weigh either way. However, when comparing the two, it’s clear that buy and hold is the superior strategy.

Buy and Hold has its detractors, and they are quick to point out the biggest flaw of the strategy: it usually only works over the long term. The danger is that most buy and hold investors are emotional to one degree or another. When the market starts to fall, they sell out, forgetting that they bought and hold for the long haul.

In other words, they were not buy and hold investors at all. Now, every time the market falls, they repeat.

By that logic, you could say that all investors are buy and hold investors, and that would be a fallacy. Just look at any millionaire that you may know – Chances are that he or she got there by trading actively and investing in the market on a regular basis.

Investors learn to recognize the value and potential of specific industries. They also learn when to hold on and when to sell out, making it much easier to make the most of their money. See if you can identify with any of the following scenarios:

Deciding on the Best Strategy for You

Regardless of whether you are a novice investor or an experienced professional, there are two basic approaches to investing: buy and hold vs. active trading.

"Buy and hold" can sound like an attractive option at first. After all, it's what your grandparents did. They bought a stock, and then held on to it until they needed the money, when they finally sold it at a profit. It can be a very appealing idea, especially if you're afraid of losing money in the stock market.

On the other hand, active trading can have its benefits, too. For one, you can make money very quickly while reducing risk. Trading also helps you to live the kind of lifestyle you might like. If you can't hold stocks for long without feeling the itch to sell, then it may be worth using active trading services or strategies to help you get through the rough patches.

Ultimately, your decision comes down to your personal preferences and trading style, which will change over time as you change. Pick the method that makes you feel the most in control of your future and stick with it.