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When a Trade Becomes an Investment

Editor's note: This piece originally ran earlier today on our newest Premium service, ETF Profits. Click here for a 14-day trial to this exciting product!

There is an old joke on Wall Street about when investors allow a position to lose more than 30%, and that security suddenly mentally transforms from a bad trade into a long-term investment. I hear the mantra that many people are long-term investors. What does that mean? Aren't we all planning to invest for the rest of our lives? Hopefully that will turn out to be a very long time.

How have long-term "holders" of investments done? Back in the late 1990s "Money" magazine was touting the purchase of index funds, specifically the S&P 500 index, and holding them for the long term. In March 2000, the S&P reached a high of 1553. Yesterday, it closed at 1306. Not accounting for dividends, on a price basis only, that is almost a 16% decline over an 11-year time frame. Is that long term enough?

Some of the most popular mutual funds also have negative returns over that same timeframe. American Funds Investment Company of America (AIVSX) lost 12% and the Fidelity Magellan Fund (FMAGX) lost 11%, not accounting for dividends or commissions on both funds.

My philosophy is somewhat opposite of the buy-and-hold believers. It would be great to pick ETFs and hold them forever. However, we live in a dynamic world, where flexibility is important.

I suggest that each position should start as a trade that could turn into a long-term investment should the price continue to increase over time. Since markets move in two directions, if a trade goes against you it is best to cut your losses quickly. This will allow you to keep the majority of your capital intact for another try, perhaps at lower prices.

Long term, the bias remains to the upside for the major indices. Short term, we just experienced a very quick correction, and the markets are in the midst of their worst week since last August. Near term, the market is oversold and due for a rally. Whether or not that rally turns out to be a continuation of the bull market run that began in September remains to be seen.

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