Buy & Hold Forever?

Should we do a Warren Buffett Buy & Hold Forever strategy? Or more aptly termed, CAN we emulate Mr Buffett's strategy?

First of all, we have to ask ourselves, do we have the confidence and mental plus emotional strength to see our portfolio plummet 30% in value AND then BUY some more to average down?

Say..you bought 1000 units of Stock ABC at Rm10 per unit. It goes up to RM12, and reached RM15. You are one happy fellow and confident that you have picked the right stock. Then came a crisis and the price dived to RM13, then RM11. If you adhere strictly to Buffett's stance, you should not be bothered by this fluctuation in price. So you hold on to it only to see it fall to RM7. At this point, you have lost 30% of your capital. The Warren Buffett in you says, great, opportunity to average down. But the real you shake in fear. You have lost RM3000 which translates into half year effort of savings. After much debate between the devil and angel in your head, you settle for an in-between. No putting more hard earned money into the stock. At the same time, you are still confident that it will eventually regain its ground and exceed previous high.

This thin thread of confidence is continually tested by bleak headlines of recession, credit crunch, financial institution collapse, sovereign defaults, record high unemployment, and whatever more which follows. The Warren Buffett in you is thoroughly defeated and you decide to salvage whatever you can and sell the stock at RM5. A painful 50% loss. You are convinced that the market will never go back to where it was, that we are in for a long depression.

Soon after, market climate changed, headlines brimmed with positive news of rising PMI, positive GDP, declining unemployment, record earnings. We got out of recession. Stock ABC swiftly shot to RM8 , RM12 and beyond.

I'm not saying that we cannot adopt the Warren Buffett strategy. As easy as it sounds, it is actually very difficult. First of all, our confidence will be shaken when the stock plunges 30% in price. Unlike Mr Buffett, we can't call up the CEO and ask him to give us a run down on the situation. We will be questioning (ourselves) if we made the right selection of stock, if there is something going on in the company that us retail investors are unaware of, did the company run into trouble, are we in an ultimate depression.

We make mistakes. We all do. So how do we protect ourselves from serious damage? Have a cut-loss policy, and stick to it! If we exercised a cut-loss strategy of 30% decrease in price, we would have sold at RM10.50 (30% drop from high of RM15). That leaves our capital intact with some gains. Even with a cut-loss strategy at 20% decrease from purchase price inflicts less damage and gives us more capital to fight another day. Remember, to recoup a 50% loss, the stock needs to gain 100%!
Having a cut-loss or trailing stop strategy will work well to preserve capital or lock in gains for many of us.