Friday, July 17, 2009

Another Reason Why a Buy/Hold Strategy is the Way to Go

By Taesik Yoon - A friend at work gave me a white paper written by Sal L. Arnuk and Joseph Saluzzi from Themis Trading LLC, an independent brokerage firm, titled Toxic Equity Trading Order Flow on Wall Street.

I had seen Mr. Saluzzi a few times before on Bloomberg TV speaking about the overvaluation of the equity markets and the rampant manipulation of stock prices by program trading. The paper expands on the latter by outlining the specific “toxic” trading strategies traders employ by “exploiting new market dynamics” and how this has negatively affected real investors.

Click HERE for a link to the PDF.

The strategies outlined and examples given provide a very good understanding of how these market exploitations work. And unlike so many other critical articles I’ve read in the past, the authors provide two clear recommendations as to what can be done (from regulatory standpoint) to stem these types of trading practices.

I agree that these practices occur. They highlight the fact that some financial institutions will do anything to make a profit—even at the expense of their own clients. And I’ll admit that while generating profits by inducing false price movements is not a new concept, being able to profit by simply buying the right to place your server in the NYSE or NASDAQ server room certainly is. (Though in this age of ever evolving technology I really should know better.)

As for the impact on the individual investor, it probably does result in some investors paying a slightly inflated price on their stock trading transactions. But over the longer-run, what are a few pennies?

If anything, this is just another reason why following a BUY/HOLD strategy is the way to go. I’ve long been a proponent of this simple investing method. If my analysis concludes that a particular stock is worth $30.00 per share in two years, then does it really matter whether I buy it at $20.01 or $20.03 today?

Of course, if these strategies somehow result in the artificial inflation in equity values over longer periods then it could jeopardize any investing strategy, including BUY/HOLD. But as someone who has seen this strategy work time and time again during his ten years of buying and selling stocks, I’ll take my chances.