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Jul 03

The Three Worst Investment Strategies Ever

Categories:

For the Newbies, Risk Management, Trading Psychology

by Rogue Traderette

I was going to write a post about some really great investment strategies that would guarantee us all a life of freedom and untold wealth but sadly I couldn’t, because those strategies are really, really difficult to find on Google.

I’m sure they’re there, they are just very well hidden between trillions of forex black boxes and to be honest after the first page on $GOOG I gave up.

It’s actually much easier to write about crap investment strategies because there are so many of them out there.  In the interests of not taking 12 days to write the post, I decided to go with some of the strategies more commonly used in the non-professional world.

So, these are my three favourite Worst Investment Strategies Ever.

1. Buy And Hold

Is buy and hold dead?  I doubt it, but it probably should be.

Buy and hold is the definitely the laziest investment strategy ever, and tends to be appealing to ‘investors’ who look at the stock market as an alternative to putting their savings in the bank.  They know they need to invest, but have no idea how and no inclination to learn so they buy bank shares or some other well-known stock and marry it, till death do them part.

There are so many problems with this strategy it makes me cry, but the biggest one occurs because of the typical mindset of the investor.

They buy the stock, watch it go up, and never lock in their profits which subsequently melt away. But they won’t sell, because in their mind they’re holding a $50 share, even though it’s now trading at $18.

Or, they watch the price fall straight off the bat, and continue to hold it because, “this is a long-term investment and the dividends are now yielding a whopping 7%!”.

Small point – it takes a lot of 7% dividends to recoup a 50% capital loss.  Worth thinking about, especially because that 7% yield is now based on 50% less capital.

Also, those precious divvies are far from a sure thing and can potentially be reduced to zero if the CEO is having a rough day.

2. Writing Naked Puts

This is sometimes promoted as a clever way to buy shares at a bargain.  And to be honest, I still find this appealing until I remember coming undone in 2008 – that was my most expensive bargain ever.  Thankyou, Lehman.

The problem with this strategy is that you make a few bucks that you get to keep if you’re right, but you lose your home if you’re wrong.  Pretty crap deal, if you ask me.

Writing Covered Calls

The only people this can possibly benefit are people who are already committing Crap Investment No. 1.  In that scenario covered calls can actually work well in a sideways to slightly down market.

But otherwise, it goes against every investment rule there is.  Letting profits run?  Er – no.  Managing risk?  No, the downside is all the way to zero, less the few bucks in your pocket from the written call.

All it does is make a really crap investment a slightly better one in junk market.  Which begs the question, why are you participating in a junk market?

You don’t have to, there are no rules that say you have to hang on through thick and thin.  The thing, in my eyes, that sets the real investors (and traders, for that matter) apart from the wanna-be’s is the ability to recognise a junk market and adjust accordingly.

This single ability has the power to change everything.  The buy and hold investor who sells when he sees his profits eroding has money ready to go when things start to look up again.  The trader who recognises that the market is not great for their strategy has the reserves to find opportunity elsewhere.

In truth, the strategy you choose is one very small piece of the investment puzzle, but if you get it wrong it will ensure you never have the opportunity to see the whole thing come together.   You can have the best psychology ever, but if your strategy sucks you are doomed from the start.

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  • Kapil

    Hi Jess, If you check into it, you will see that naked puts and covered calls are the exact same thing. One is the synthetic equivalent of the other. It is interesting how people percieve them so differently. BTW, I enjoy reading your blog, keep up the good work!

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  • JC

    Hahahaha. I wonder if any of these comments are from profitable investors. Jess, I am a profitable day trader & I love your blog. It doesn’t even matter if you make the big bucks yourself, you say the right things. I find very little of yours that I disagree with, and this blog is not one of those.

    Cheers. Carry on.

    • http://www.roguetraderette.com/ Jessica Peletier

      Thanks JC :)

  • http://twitter.com/jasonchanning Jason Channing

    I’m only following you because your I think your cute. Outside of that. ??? questionable!

  • http://trendfollower.wordpress.com/ Bevan Lewis

    Its often a matter of terminology. Buy and Hold is a much maligned term, and if you interpret that as buying stocks and holding to them whatever, then it certainly is a poor strategy. I’m sorry, but anyone who is willing to hold onto a stock and let it go to $0 is just a fool.
    The strategy Thomas talks about seems more like Value investing. Holding good stocks longterm, and keeping your powder dry to buy after crisis is a great idea. Still wouldn’t hold them to $0 though!
    Writing options can be successful of course, but it is dangerous with excessive leverage. The risk of Black Swan events in combination with leverage is the main problem. Managed funds writing options often have lovely steady streams of returns, until they go bust! If you’re talking about how successful a strategy is by looking at fund results, it needs to be over the long term and include the effect of survivorship bias (i.e. take into account all the funds which investors didn’t get a cent back from or which liquidated!).

    • http://www.roguetraderette.com/ Jessica Peletier

      Couldn’t have said it better myself :)

  • http://twitter.com/TullyStoll Cheryl Tully Stoll

    I love your attitude.

  • Trader

    honestly, i don’t think you understand a lot about markets! it’s nice to read your blog as you’re really cute to look at, but yeah that’s it! have you ever gained money constantly by trading (this is a honest question!)?

    • http://www.roguetraderette.com/ Jessica Peletier

      You’re right, I’m just pretty with no brain. Don’t worry, you’re not the first to think that.

  • Thomas Janek

    i really like your blog, as you have good ideas! but this post hasn’t any! :(
    in fact, buy and hold is still a great investment strategy for the very (!) long turn especcially if your pick blue chips or indices. in the end chances are good you make money, especcially if you buy after a massive loss like in 2008!
    second, i have never written options or understand much about it, but I have seen comparisons of professional managed account. guess what – the only ones that made constant profit without much drawdown were those who wrote options!
    so maybe you just don’t really understand how to make money from these strategies, but that doesn’t mean other people cannot, either!

    • http://www.roguetraderette.com/ Jessica Peletier

      Hi Thomas, thanks for responding.

      Firstly, I think not writing naked puts is a brilliant idea! Sorry you missed that one ;)

      The other thing is I’m talking about using these strategies stand-alone, not as part of a broader strategy. Call writing can have a place – like I said, it’s good in a flat or falling market and managed accounts tend to be invested at all times so writing CC’s is probably effective for them as long as they don’t do it through a raging bull market.

  • JR

    There is so much structurally wrong with this analysis that it is tough to even begin. Writing covered calls does not prevent you from letting winners run, you can roll contracts out and up and generate additional income, also over-write, and it is more of selling over-priced volatility. Selling naked puts is a much better strategy than ever buying a stock if you properly understand the dynamics of the options market….

    • http://www.roguetraderette.com/ Jessica Peletier

      Hi JR,

      I’m talking primarily about the non-professional investors here, who on the whole generally don’t have a great handle on the dynamics of the options market.

      Personally I find that while rolling a failed option strategy feels good, it is the equivalent of a buy and hold – if you just give it more time, it will recover. (fingers crossed).

      When you roll, you close out the loser (realise the loss) which is fine, but then you make the same mistake again by selling another call.

      To my mind, if you lose, you lose and move on.
      Sometimes rolling might work, sure, same as averaging down or holding through the GFC might eventually let you out at breakeven.

      • Vinny

        Strong reply, Jesica. I think you were spot-on. Capping gains and letting losses run is the opposite of proper trading no matter how you dress it up.