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Wednesday, February 17, 2010

Today's Investing Strategies: Buy & Hold, FIFO & LIFO

Explanation for Jumpy Markets

Want a(nother) reason for heightened stock market volatility?

More investors are switching from buy-and-hold to "FIFO": first in, first out -- and ask questions later.

Such is the aftermath of a decade-plus of negative overall stock market returns. And that's before inflation.

As I've blogged before, welcome to "risk without return."

Risk Without Return

When stocks are trading on momentum and liquidity rather than fundamentals -- as now appears to be the case -- you never know when the "jig" is going to be up.

All you know is that the exits are narrow, and that the penalty for getting out late is horrific (ask tech stock investors from a decade ago).

So, every "dip" and reversal sends skittish investors looking for daylight.

When the scare passes, these same, jumpy traders have to buy back in again.

LIFO: FIFO for Experts

Of course, there's an even higher stakes trading strategy than FIFO for profiting from precarious markets -- albeit one best practiced only by experts: 'LIFO,' or last in, first out.

Also known as short selling, it consists of betting against bubbles just as they're about to deflate.

Whereas investors who "go long" make money when something goes up, short sellers profit when whatever they short goes down.

In fact, little-known hedge fund investor John Paulson (no relation to Henry) pocketed something like $20 billion the last three years betting that housing would collapse.

As Wall Street has just demonstrated (again), the best way to profitably short-sell a bubble is to know when it's about to pop, for real.*

And the best way to do that is to have helped inflate it.

*What do you call a short-seller who is right but early (like all the pro's who shorted overvalued tech stocks in '98 and '99)?

Wrong . . . and busted.

That's because if you short-sell something that keeps going up, you face wave after wave of margin calls requiring you to put up more money.

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