Buy and Hold Isn't Enough

The market has been falling -- and the signs read rough road ahead.

The Chicago Fed's National Activity Index, a weighted average of 85 economic indicators, is falling, as are economists' GDP growth forecasts. Unemployment is back on the rise, the Fed's second round of quantitative easing is coming to an end, and the housing market remains a mess. No wonder the bears have been roaring out of hibernation!

It's not looking good
I don't know what the market will actually do. But after studying credit bubble collapses and the 10-year chart for the S&P 500 below, I'm betting on low returns and high volatility over the next 10 years -- just like last decade. Check out the chart below.

Source: Capital IQ, a division of Standard & Poor's.

I mean, 2.3% annual returns. That's all the market could muster -- including dividends! In real terms, that's nothing. Nada. Zilch.

A better way
The status quo isn't enough. We need more than bottom-up, long-term buy and hold during the next volatile decade. Otherwise we could end up generating zero real returns like I expect from the market -- or worse.

To make money in this new investing environment, here's how I am managing my $50,000 on-line portfolio.

1. Pay attention to the trends and find the best opportunities in them.
2. Go with the odds.
3. Have a flexible trading strategy.

Let's take a quick look at how each of these steps works. Then, if you're interested, I'll present you with a fantastic opportunity I've found using my new approach.

Know the big picture
Today, more than ever, investors can't ignore the top-down view. Investors still have to analyze companies from the bottom up, but Peter Lynch reminds us, "A person infatuated with measurement, who has his head stuck in the sand of the balance sheets, is not likely to succeed."

He's exactly right -- especially today. I missed a 19-bagger with Amazon.com because I was too wrapped up in its financial statements to buy shares of the revolutionary on-line retailer in August 2001.

Lynch would not be proud. That's why I am opening up my mind and researching E-Commerce China Dangdang (NYSE: DANG) and Renren (NYSE: RENN), the so-called Amazon.com and Facebook of China, respectively. Their business models have loads of potential and their stocks have been crushed recently. I think these could be very promising investments.

Go with the odds
But it takes more than potential and a falling stock price to separate me from my capital. I have to understand why the odds are in my favor. And that comes from a combination of business and financial analysis.

Take Infinera (Nasdaq: INFN) and Cisco (Nasdaq: CSCO), for examples. Both companies sell communications equipment and, right now, the market hates their stocks. Infinera's next-generation product, its 100G photonic integrated circuit, is due out in 2012. If past is prologue, it's going to be a big hit. On the other hand, Cisco is trying to find new avenues of growth. Although I can't be sure either company will turn things around, I think the odds -- and the payoff -- favor Infinera.

Don't be afraid to trade
In the short run, psychology exerts significantly more influence on stock prices than the fundamentals of the businesses. Buying attracts more buyers, pushing prices up further, and the opposite is true with selling. In volatile markets, these swings can happen more frequently and more profoundly. Here's how volatility looked over the 1965 to 1981 stretch:

Source: Crestmont Research.

This is exactly why every investor should have a trade plan in volatile markets. A trade plan is a guide that shows when to buy when the odds are in your favor and when to sell when they are not.

I've created trade plans for two stocks I've researched: Google (Nasdaq: GOOG) and Caterpillar (NYSE: CAT). (I've written about Google, here.) According to my estimates, buying the search ad giant's shares below $460 gives three times as much upside return as downside risk. That's an attractive point to start buying.

Shares of the earth-moving-equipment maker don't look as attractive. I estimate its reward/risk ratio is about 1. That may be OK for some investors, but that's too much risk for me. If Caterpillar were in my portfolio, I would consider selling some shares to reduce my risk.

A trade plan seems to go against the Fool's mantra. Foolish investors prefer to buy and hold -- and I do, too. But not every investment lends itself to buying and holding, because circumstances change. With volatility on the rise, trading is not a dirty word when it's rooted in solid analysis of a company's business fundamentals.

Let's make some money
Financial markets and the U.S. economy have recovered from their 2009 lows, but we're not out of the woods yet. I don't know if the market's losing streak will persist, but I do think the volatility will persist over the next decade. To be ready, I've come up with this new investing strategy because:

1. Powerful things happen when trends converge, diverge, emerge, or combine together.
2. I would rather be vaguely right with the odds than precisely wrong with intrinsic value.
3. Sometimes it's better to trade, and other times it's better to hold.

I'm going to invest $50,000 of my own money with this approach, which I expect to pay off over the next several volatile years.

If you'd like to find out about the three strong trends and the money-making trade that I see, I'll be happy to send you a brand-new report I've written on the subject for free. Simply click here and enter your email address in the box to let me know where you'd like me to send it.