Why You Shouldn't Invest Like Warren Buffett

Note from Managing Editor Sara Nunnally: Everybody knows who Warren Buffett is… The Oracle of Omaha has amassed billions of dollars by buying up stocks at great prices. Sometimes he holds them for years before seeing a big profit.

As a billionaire, he’s got the means to do this. He can afford to have a huge chunk of money stay in the market for years at a time. Today’s investor, like you and me, has to be more nimble. We have to be able to take profits at a much faster pace.

In this environment, as our guest editor Zachary Scheidt says, “buy and hold” investing is dead. In this environment, we need to be traders…

Zach is the editor of Velocity Trader, and his service just saw a gain of 44% in a single day. Perhaps this is evidence that you should be investing like Zach, and not like Warren Buffett.

Read on! (And don’t forget to sign up for Smart Investing Daily and let me and fellow editor Jared Levy simplify the market for you with our easy-to-understand articles.)

Buy and Hold Investing Is Dead

In my previous position as a hedge fund manager, I had one particular client that I will always remember fondly. George was a retired oil driller who had been lucky enough to make some great energy investments, and smart enough to take some profits off the table.

George had a few million dollars invested in one of our funds, and a large position in a single drilling company that he had fallen in love with. What I really liked (most of the time) about George was his predictability.

You see, every Friday afternoon — without fail — George would call the office to count his money. A typical conversation would go something like this (keep in mind, George has a thick “Bahstahn” accent):

George: Hi, Zach! How’d we do this week?

Zach: Hi, George… Well, the fund is up about 1.8% for the week and we’re looking at a deal that…

George: ONLY ONE POINT EIGHT? C’mon Zach, you ghatta do bettah than that!

Zach: You’re right; we’ll try to do better next week. We’re tracking two different companies that have plans to…

George: What about Atlas (referring to his favorite drilling stock)?

Zach: Well, Atlas is down about 37 cents on the day.

George: What happened??

Zach: Not too much — the board authorized the second-quarter dividend and…

George: Can you print that out and fax it to me?

Zach: Sure, George. Have a great weekend.

George: (click)

It got to be almost humorous (except for the interruption to my research every Friday). George wanted to know everything about the company — down to the press releases for each well that was initiated. But he never actually traded the stock. He simply took his lumps when times were bad, and rejoiced when times were good.

The Difference Between Market Environments

During bull market periods, buy and hold works beautifully. Simply pick a successful company (it almost doesn’t matter which company) and enjoy the profits as the stock trades higher. The game is easy — nearly every stock rallies.

If you want better returns, pick more aggressive companies or use leverage (borrowing money to buy more shares). During a bull market, risk doesn’t matter. That’s because prices continue to tick higher and every pullback is just an opportunity to buy more.

But today’s environment is much different. As you should already know, our economy is facing serious risks from a number of different angles:

• Unemployment has been above “acceptable” levels for more than three years now.
• Housing values continue to plummet.
• Food and energy inflation is cutting into consumer as well as corporate spending.
• Emerging market growth is in danger of stalling.
• European debt could sink the global financial system.

And the list goes on… This is certainly NOT a long-term bull market, and the benefits of a buy-and-hold strategy are slim to none!

Trading Is the Answer

So what is an investor to do with this market full of risk?

In order to be truly successful in today’s market, investors need to adapt a more nimble approach. They need to become traders!

I’m not saying you need to fire up a high-powered computer and begin entering orders each and every day. You probably don’t have time for that. As a professional investor even I don’t have time for all that action…

Trading is much less about the amount of activity, and much more about the profit opportunity. To survive in our turbulent economic environment, you need to be able to capture the opportunity that markets present — and sit on the sidelines when the opportunities aren’t good.

For me, this means watching the price action and taking a few key positions each week. And it means trading in sync with the market, whether prices are rising or falling. I’m just as comfortable making money off a falling retail stock as I am buying a precious metal miner. I’m also just as comfortable holding a position for a few days as I am holding for a few months.

It all depends on the opportunity!

Take Sears Holdings (SHLD:NASDAQ) for instance. On June 22, I recommended readers of my Velocity Trader service take a short (bearish) position on Sears. The retail company has been under pressure and was primed for another wave of selling.

To our delight, the very next day Sears dropped sharply and our bearish bet was up 44%. As a trader, when I have an overnight gain of 44%, I like to take some of the profits off the table. It just makes sense to ring the register when the market gives you that much of an advantage.

But at the same time, I still believe Sears has much farther to fall. The company’s challenges are still in play, and investors are still likely to sell their shares and push the stock lower. So we only sold half of our position and let the rest run for much larger profits.

Volatility Means Opportunity

That’s how the trading game is played. You isolate opportunities, and then you execute. When you have profits, you capture them. You manage your losses and continually monitor the markets for new setups.

Being a trader gives me a distinct edge over “buy and hold” investors. You see, volatility is my friend. When stocks begin to make wild moves, that’s when I am able to step in and make a buy or sell transaction and see my profits begin to accumulate.

Buy-and-hold investors simply have to ride out the roller coaster. And watching your net worth bob up and down like a yo-yo is no fun at all… Just ask George.

You see, it does very little good to monitor every tick and tack of a company that you like — unless you are going to act on the information. As a trader, I continually monitor a watch list of about 85 to 100 stocks, and rotate which stocks are on my list based on what type of opportunities the market is giving.

Your Stocks, Your Decision

Would you indulge me in a quick exercise?

Write down the ticker symbol of the three largest positions in your account. (If you’re not holding any stocks, write down three trades you are interested in.) Now next to the ticker, briefly summarize why you like this stock and what you expect the stock to do.

Now keep that sheet next to your computer or in your top desk drawer. Look at it each day. Ask yourself if your reasoning for holding this stock is still valid. Ask yourself if it is still the best opportunity for your money. Ask yourself if it has already accomplished what you expect it to.

If you find that your stock has already served its purpose, or that your original investment thesis is no longer valid, then it’s time to move on. Sell that position and look for the next opportunity.

And voilà! You’re a now trader!

Editor’s Note: Zach is right. Buy-and-hold investing is dead. But it is not bad news, at least for Zach and his Velocity Trader subscribers. As a former hedge fund manager, Zach knows the tricks and techniques it takes to get ahead of the market.

He just released his latest report to his readers. The green light is flashing on a set of potentially huge trades. To read the details, follow the link.

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