According to many market experts, investors should buy and hold always and forever, right? If you’ve been told that before you might be surprised to learn that even the S&P 500 changes its holdings every so often. In fact, according to a recent Business Insider article:
“Since 1980, over 320 companies were deleted from the S&P 500 for business distress reasons”
Now some of these companies merged with others, some were absorbed in takeovers, but a good amount of them were dropped from the index for performance reasons. They no longer qualified as one of the top 500 US companies. If you do the math, the index has averaged 10 changes per year since 1980. The S&P 500 is widely regarded as the benchmark for most US investors. So when the index is actively making changes to its holdings, why must investors sit tight no matter what happens?
This statistic about changes to the S&P 500 interests us because we frequently see investors holding onto stocks they bought at much higher prices. Their reasons for holding on typically originate from the misguided belief that buy and hold means forever.
Ben Carlson had a great post back in September titled, “Some Stocks Don’t Come Back”, where he wrote:
“The fact that a company traded for a certain price in the past gives investors a false sense of hope that it will automatically go back to that previous price point. Sometimes this works, but trying to catch a falling knife can be a dangerous strategy if you don’t know what your’re doing.”
Danger lies in taking the buy and hold mantra too literally. The general message of buy and hold is a good one: think long term. However, taking it literally to mean never, ever sell is foolish.
What we look to accomplish through the use of point and figure charting is simple: measure supply and demand. We’ll never completely know why people decide to sell a stock, but we do know that when too many sellers show up at once supply can take over. An abundance of supply leads stocks into negative trends and alerts us to potential problems. By using these charts we look to hold onto sound investments for long periods of time and avoid questionable ones. There’s no pride in holding onto a $7 stock that you bought for $67.
Investing for the long term is a good mindset, but it doesn’t have to mean buy and hold forever. As you can see, even the passive S&P 500 index makes active decisions about what companies comprise it.