The Pitfalls of Buy and Hold: How to Improve Returns with Smart Trading Strategies
Learning from Zoom’s Rise and Fall – Smart Investing vs. Buy and Hold
Hi everyone! Those who follow our newsletter know I’m not a fan of the buy-and-hold approach for individual stocks, though holding indexes, ETFs, and other diversified funds long-term can be a viable strategy. In today’s video, we’ll examine a popular stock that long-term investors might have held onto, only to face a disappointing outcome. We’ll explore the behavioral aspects of the chart and metrics like return on risk and the impact of leverage
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Zoom Video Communications: A Case Study
Zoom became incredibly popular during the pandemic, skyrocketing from approximately $90 in February 2020 to a high of $590 in just 36 weeks—a 550% increase. However, over the next 18 months, Zoom’s stock price recalibrated back to pre-pandemic levels. This decline highlights the issues with a buy-and-hold strategy for individual stocks. Long-term investors not only endured a significant decline but also suffered from opportunity cost—having their capital tied up and losing the chance to invest elsewhere.
The Psychology Behind Market Movements
Price charts are closely tied to the behavior and psychology of market participants. Prices are driven by buying and selling actions, often reflecting investor enthusiasm, greed, denial, fear, and eventual capitulation. We can categorize these participants into groups: smart money, institutional investors, and the general public. Smart investors buy early, institutions accumulate positions, and the general public often buys at the peak and sells at the bottom.
Comparing Investment Strategies
Smart Money:
Buy Price: $107 (just above the 20-week moving average)
Sell Price: $460 (after a change in momentum)
Return: 430%
Return on Risk: 1 to 4.3 (100% positional risk)
General Public:
Buy Price: $320 (during rising enthusiasm)
Sell Price: $107 (capitulation)
Return: -66%
Return on Risk: 1 to 0.66 (100% positional risk)
My Trading Approach
My strategy improves on smart money returns by incorporating risk management and leverage. Here’s a basic concept of my approach:
Identify Consolidation and Breakout:
Look for lateral consolidation on the weekly chart.
Enter at the breakout with positive indicators (20-week moving average and MACD).
Define Risk:
Place a stop loss within the consolidation range, limiting risk to 10%.
Exit Strategy:
Use indicators like the 20-week moving average and MACD to signal trend changes.
Assume an exit price around $405.
Return on Risk:
Buy Price: $88
Sell Price: $405
Return: 360%
Return on Risk: 1 to 36 (10% risk)
The Impact of Leverage
By using a stop loss, you limit risk and can safely apply leverage. Here’s how leverage changes dynamics:
Investment: $5,000
Risk: $500 (10% of $5,000)
Leverage: 2 to 1
Profit: $26,000 (with leverage)
Key Takeaways
Be aware of stock chart phases and avoid getting caught in over-enthusiasm.
Establish a buying point with a reasonable stop loss and solid risk management.
Apply leverage to enhance returns while managing risk.
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