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Patience Pays Off

Author: James Brumley (info)
Website: http://bluegrassportfolio.com
Posted: March 26th, 2007 at 7:52 pm EST
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Today we’ll look at finding the optimal holding period. In short, while most everyone seems to have mastered the art of getting into a trade, getting out is a different story. Some traders get out too soon, while others get out too quickly. We won’t be able to perfectly fix that today, but we do have some food for thought that should help make that decision easier. As always, the answer depends on your style and goals.

For the purpose of this lesson, we’ll be looking at our Multi-Cap Growth Portfolio trades (a sub-service of our Aggressive Stock Trader service). This is a fun and easy portfolio to analyze, because it trades less frequently, but has had tremendous results (up 89% since its inception in late 2002). As we started studying and tweaking the portfolio, we started seeing various holding periods. Of course this led to the obvious question - was there any relationship between the percentage return on any trade and the amount of time we held it?

Conventional wisdom says yes, there is a time/return correlation. But you know how I feel about conventional wisdom. I’d rather test the theory myself, which we did. In the chart below, we’ve compared the percentage returns of our profitable Multi-Cap Portfolio trades to the number of days we held them. The theory did hold up; the most profitable trades were held the longest. Our very biggest winners (50%+) were held an average of 68 days, while our weakest winners (5%-) were only held about 43 days. While the trend on the graph is pretty evident already, the red line represents an average of the time/return correlation.

Multi-Cap Portfolio: Holding Period Vs. Average % Return

Now, before you decide to start holding all of your positions for 68 days, realize that there is a difference between being patient and being stubborn. Patient traders discard losing trades and hold the winning ones. Stubborn traders hold on to both winning and losing trades. In other words, don’t draw the wrong conclusion that longer holding periods guarantee higher returns. In fact, time can be your worst enemy in a losing trade.

Instead, our point today is simply that it’s highly unlikely you’ll get major returns on a stock in only a few days. You might get moderate returns in a few days, but you won’t get major returns. It pays to be patient.

In the interest of complete understanding, the most profitable of these trades also had these three following characteristics:

1: At no point in time were they ever unprofitable. They may have stagnated or fallen slightly after a rise, but they never fell under our original entry level.

2: They went in the right direction at the very beginning. Getting started with a profit cushion allows you to tolerate a little volatility (i.e. buys you time).

3: They all had reasonable fundamentals. Not all of them were profitable companies, but they all were making reasonable progress towards profitability.

Remember, entering a trade is only the first step in the process. Proper holding and exit disciplines are also needed if you want to achieve top profitability.

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